Intertemporal utility and correlation aversion

Andersen, Steffen; Harrison, Glenn; Lau, Morten; Rutstroem, Elisabet

Abstract

Convenient assumptions about qualitative properties of the intertemporal utility function have generated counter-intuitive implications for the relationship between atemporal risk aversionand the intertemporal elasticity of substitution. If the intertemporal utility function is additively separable then the latter two concepts are the inverse of each other. We review a simple theoretical specification with a long lineage in the literature on multi-attribute utility, and demonstrate the critical role of a concept known as intertemporal risk aversion or intertemporal correlation aversion.This concept is the intertemporal analogue of a more general concept applied to two attributes of utility, but where the attributes just happen to be the time-dating of the good. In the context of intertemporal utility functions, the concept provides an intuitive explanation of possible differences between (the inverse of) atemporal risk aversion and the intertemporal elasticity of substitution. We use this theoretical structure to guide the design of a series of experiments that allow us to identify and estimate intertemporal correlation aversion. Our results show that subjects are correlation averse over lotteries with intertemporal income profiles, and that the convenient additive specification of the intertemporal utility function is not an appropriate representation of preferences over time.

Citation

Andersen, S., Harrison, G., Lau, M., & Rutstroem, E. (2011). Intertemporal utility and correlation aversion

• Working Paper Type: Working Paper
• Publication Date: Mar 1, 2011
• Deposit Date: Dec 7, 2012
• Publicly Available Date: Dec 7, 2012
• Series Title: Durham University Business School Economics Finance Accounting Working Papers
• Public URL: https://durham-repository.worktribe.com/output/1699628
• Publisher URL: http://www.dur.ac.uk/business/faculty/working-papers/