Abstract We consider the problem of optimal investment with intermediate consumption in a general semimartingale model of an incomplete market, with preferences being represented by a utility stochastic field. We show that the key conclusions of the utility maximization theory hold under the assumptions of no unbounded profit with bounded risk and of the finiteness of both primal and dual value functions.
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This content will become publicly available on June 1, 2025
Background Risk and Small-Stakes Risk Aversion
Building on Pomatto, Strack, and Tamuz (2020), we identify a tight condition for when background risk can induce first-order stochastic dominance. Using this condition, we show that under plausible levels of background risk, no theory of choice under risk can simultaneously satisfy the following three economic postulates: (i) decision-makers are risk averse over small gambles, (ii) their preferences respect stochastic dominance, and (iii) they account for background risk. This impossibility result applies to expected utility theory, prospect theory, rank-dependent utility, and many other models. (JEL D81, D91)
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- Award ID(s):
- 1944153
- PAR ID:
- 10511608
- Publisher / Repository:
- American Economic Association
- Date Published:
- Journal Name:
- American Economic Review: Insights
- Volume:
- 6
- Issue:
- 2
- ISSN:
- 2640-205X
- Page Range / eLocation ID:
- 262 to 276
- Format(s):
- Medium: X
- Sponsoring Org:
- National Science Foundation
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