Dynamically Consistent Preferences with Quadratic Beliefs

JOURNAL OF RISK AND UNCERTAINTY, Vol 14 No 2

Posted: 30 Apr 1997

See all articles by Jürgen Eichberger

Jürgen Eichberger

Heidelberg University - Alfred Weber Institute for Economics

Simon Grant

Rice University - Department of Economics; Australian National University

Abstract

This paper characterizes a family of preference relations over uncertain prospects that (i) are dynamically consistent in the Machina sense and, moreover, for which the updated preferences are also members of this family and (ii) can simultaneously accommodate Ellsberg and Allais type paradoxes. Replacing the 'mixture independence' axiom by 'mixture symmetry', proposed by Chew et al (1991) for decision making under objective risk, and requiring that for some partition of the state space the agent perceives ambiguity and so prefers a randomisation over outcomes across that partition (proper uncertainty aversion), preferences can be represented by a (proper) quadratic functional. This representation may be further refined to allow a separation between the quantification of beliefs and risk preferences that is closed under dynamically consistent updating.

JEL Classification: D81

Suggested Citation

Eichberger, Jürgen and Grant, Simon Harold, Dynamically Consistent Preferences with Quadratic Beliefs. JOURNAL OF RISK AND UNCERTAINTY, Vol 14 No 2. Available at SSRN: https://ssrn.com/abstract=3928

Jürgen Eichberger

Heidelberg University - Alfred Weber Institute for Economics ( email )

Heidelberg, D-69117
Germany

Simon Harold Grant (Contact Author)

Rice University - Department of Economics ( email )

6100 South Main Street
Houston, TX 77005
United States
713-348-3332 (Phone)
713-348-6329 (Fax)

Australian National University ( email )

Coombs Building 9
Canberra, Australian Capital Territory 0200
Australia
61-2-6125-4602 (Phone)
61-2-6125-3051 (Fax)

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