Temporal Risk and the Nature of Induced Preferences

It has been known since the work of H. Markowitz (“Portfolio Selection: Efftcient Diversification of Investments,” Yale Univ. Press, 1959) and J. Mossin (Amer. Econ. Rev. 59 (1969), 172-174) that even an individual whose underlying preferences satisfy the von Neumann-Morgenstern axioms will not choose over delayed (i.e., “temporal”) risky prospects in a manner which can be modelled as expected utility maximizing. Since most economically important instances of risk taking (insurance, real investment, agriculture, career training) involve delayed as opposed to immediately resolved risk, the standard use of expected utility theory to model such decisions must be questioned. In this paper the technique of “generalized expected utility analysis” (M. J. Machina, Econometrica 50 (1982), 277-323) and the theory of support functions (R. T. Rockafellar, “Convex Analysis,” Princeton Univ. Press, 1970) are applied to exactly model and hence determine the nature of preferences over temporal risky prospects. Journal of Economic Literature Classification Numbers: 022, 026.