Economics Lunch Seminar with Peter Wikman
Research, Outreach, Seminar
2020-02-17 at 12:05
2020-02-17 at 13:00
Sveavägen 65, conference room floor 7
Peter Wikman, TSE
Separable and Dynamic Consistent Preferences
ABSTRACT: This paper develops a model of a decision-maker who dynamically evaluates outcomes as gains and losses relative to an endogenously determined reference point. The model can be interpreted as if the decision-maker optimally chooses each reference point given a trade-off between anticipatory utility and loss aversion: anticipating a better outcome jointly increases current utility and the reference point for tomorrow’s outcome. The main result is an axiomatic characterization of such preferences over infinite-horizon temporal lotteries. The obtained utility representation has a recursive form that is amenable to dynamic programming, and it provides an operational welfare criterion. I also show that it is possible to uniquely identify the decision-maker’s utility representation without observing her reference points. Finally, the model is applied to asset pricing and life-cycle consumption. In the first application, the model can account for a sizable equity premium together with low risk aversion and low aversion to temporal resolution of uncertainty. In the second application, it can account for excess sensitivity and smoothness of consumption responses to permanent income shocks, which vanish for large shocks.