Preferences for Consumption Streams: Scale Invariance, Correlation Aversion, and Delay Aversion Under Mortality Risk

Kenneth C. Lichtendahl () and Samuel E. Bodily ()
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Kenneth C. Lichtendahl: Darden School of Business, University of Virginia, Charlottesville, Virginia 22903
Samuel E. Bodily: Darden School of Business, University of Virginia, Charlottesville, Virginia 22903

Operations Research, 2010, vol. 58, issue 4-part-1, 985-997

Abstract: Lifetime financial decisions often require a decision analyst to elicit a decision maker's preferences for consumption streams. In assessing such preferences, the analyst might look for a set of reasonable conditions to check when selecting a utility form. We provide such a set of conditions and show that they lead to the multiplicative-expo-power (MEP) utility form. Some of our conditions involve trade-offs under certainty and others relate to choices under uncertainty. In the deterministic setting, we invoke increasingness, continuous differentiability, mutual preferential independence, and preferential scale invariance. In the uncertainty setting, we invoke componentwise risk aversion, a utility independence condition, and correlation aversion. We apply the MEP utility in a life-cycle consumption-planning problem under mortality risk. In this context, we find that the correlation-averse MEP utility is more realistic than, and as tractable as, the popular correlation-neutral additive-power and additive-exponential utilities. We show that the correlation-averse decision maker prefers to consume more in life and leave less behind in death. In addition, we demonstrate that the correlation-averse decision maker is more averse to delaying consumption in the face of mortality risk.

Keywords: decision analysis; multiattribute utility; life-cycle consumption; mutual preferential independence; utility independence (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (4)

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