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Incomplete market demand tests for Kreps-Porteus-Selden preferences

Felix Kubler, Larry Selden and Xiao Wei

Journal of Economic Theory, 2020, vol. 185, issue C

Abstract: What does utility maximization subject to a budget constraint imply for intertemporal choice under uncertainty? Assuming consumers face a two period consumption-portfolio problem where asset markets are incomplete, we address this question following both the standard local infinitesimal and finite data approaches. To focus on the separate roles of time and risk preferences, individuals maximize KPS (Kreps-Porteus-Selden) preferences. The consumption-portfolio problem is decomposed into a one period portfolio problem and a two period certainty consumption-saving problem. We derive demand restrictions which are necessary and sufficient, for portfolio choices and certainty intertemporal consumption to have been generated by maximization, respectively, of a one period expected utility representation and a certainty representation of time preferences. Conditions are provided for recovering the building block time and risk preference utilities. For the finite data case, we derive a set of linear inequalities that are necessary and sufficient for observations to be consistent with the maximization of KPS utility.

Keywords: Kreps-Porteus-Selden preferences; Expected utility; Contingent claims; Integrability; Incomplete markets (search for similar items in EconPapers)
JEL-codes: D01 D11 D80 (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:185:y:2020:i:c:s002205311930122x

DOI: 10.1016/j.jet.2019.104973

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