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Disentangling Intertemporal Substitution and Risk Aversion Under the Expected Utility Theorem

Chi-Lei Oscar Lau

Published 2008 in The B.E. Journal of Theoretical Economics

ABSTRACT

Abstract This paper presents an axiomatic approach to separately control for the attitudes toward intertemporal substitution and risk aversion under the expected utility theorem. The standard time-separable form is recovered only if the functions dictating the two attitudes are identical. Risk aversion is defined on consumption amount rather than on utility (as in Kihlstrom and Mirman (1974 and 1981)). Moreover, the agent is allowed to trade his lottery outcome to optimize his consumption. As a result, this approach provides a straightforward extension of the familiar Arrow-Pratt results to multiple periods. These include categorizing, measuring, and comparing risk aversions.

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