Numéraire-invariant preferences in financial modeling

Constantinos Kardaras

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: We provide an axiomatic foundation for the representation of numéraire-invariant preferences of economic agents acting in a financial market. In a static environment, the simple axioms turn out to be equivalent to the following choice rule: the agent prefers one outcome over another if and only if the expected (under the agent's subjective probability) relative rate of return of the latter outcome with respect to the former is nonpositive. With the addition of a transitivity requirement, this last preference relation has an extension that can be numerically represented by expected logarithmic utility. We also treat the case of a dynamic environment where consumption streams are the objects of choice. There, a novel result concerning a canonical representation of unit-mass optional measures enables us to explicitly solve the investment--consumption problem by separating the two aspects of investment and consumption. Finally, we give an application to the problem of optimal numéraire investment with a random time-horizon.

Keywords: preferences; choice rules; numéraire-invariance; optional measures; investment–consumption problem; random time-horizon utility maximization (search for similar items in EconPapers)
JEL-codes: G10 (search for similar items in EconPapers)
Date: 2010
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Citations: View citations in EconPapers (7)

Published in Annals of Applied Probability, 2010, 20(5), pp. 1697-1728. ISSN: 1050-5164

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