Dynamic Preference for Flexibility

Authors

  • R. Vijay Krishna,

    1. Dept. of Economics, Duke University, Durham, NC 27708, U.S.A.; vijay.krishna@duke.edu
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  • Philipp Sadowski

    1. Dept. of Economics, Duke University, Durham, NC 27708, U.S.A.; p.sadowski@duke.edu
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    • We would like to thank, without implicating, Haluk Ergin, Sujoy Mukerji, Wolfgang Pesendorfer, Todd Sarver, Norio Takeoka, six anonymous referees, and Philippe Jehiel for helpful comments and suggestions, and Vivek Bhattarcharya, Matt Horne, and Justin Valasek for valuable research assistance. Krishna gratefully acknowledges support from the National Science Foundation (Grant SES-1132193).


Abstract

We consider a decision maker who faces dynamic decision situations that involve intertemporal trade-offs, as in consumption–savings problems, and who experiences taste shocks that are transient contingent on the state of the world. We axiomatize a recursive representation of choice over state contingent infinite horizon consumption problems, where uncertainty about consumption utilities depends on the observable state and the state follows a subjective Markov process. The parameters of the representation are the subjective process that governs the evolution of beliefs over consumption utilities and the discount factor; they are uniquely identified from behavior. We characterize a natural notion of greater preference for flexibility in terms of a dilation of beliefs. An important special case of our representation is a recursive version of the Anscombe–Aumann model with parameters that include a subjective Markov process over states and state-dependent utilities, all of which are uniquely identified.

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