Utility-Based Utility

David Cass

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

Abstract: A major virtue of von Neumann-Morgenstern utilities, for example, in the theory of general financial equilibrium (GFE), is that they ensure intertemporal consistency: consumption-portfolio plans (for the future) are in fact executed (in the future) — assuming that there is perfect foresight about relevant endogenous variables. This note proposes an alternative to expected utility, one which also delivers consistency between plan and execution — and more. In particular, it turns out that one special case is in fact simply discounted (subjective) expected utility. Moreover, this alternative formulation affords an extremely natural setting for introducing extrinsic uncertainty. The key idea behind my approach is to divorce the concept of filtration (of the state space) from any considerations involving probability (on the state space), and then concentrate attention on nested utilities of consumption looking forward from any date-event: utility today depends only on consumption today and prospective utility of consumption tomorrow, utility tomorrow depends only on consumption tomorrow and prospective utility of consumption the day after tomorrow, and so on.

Keywords: Utility theory; Expected utility; Intertemporal consistency; Extrinsic uncertainty; Cass-Shell Immunity Theorem (search for similar items in EconPapers)
JEL-codes: D61 D81 D91 (search for similar items in EconPapers)
Pages: 9 pages
Date: 2007-12-15, Revised 2008-01-04
New Economics Papers: this item is included in nep-dge, nep-hpe and nep-upt
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Working Paper: Utility-Based Utility (2007)
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