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ABSTRACT

This paper characterizes conditions under which asset returns and consumption are consistent with risk-averse preferences. It is shown that risk aversion is equivalent to “zero arbitrage” on a transformation of the payoff space. The implicit state prices which are dual to this no-arbitrage condition can be interpreted as prices of “pure consumption hedges.” This zero-arbitrage restriction implies the usual restrictions associated with nonsatiation. The analysis holds in both complete and incomplete market settings.