Matthew J. Sobel. Optimization Criteria, Discounting and Risk Neutrality

Abstract. This talk concerns the logical foundations of time preference and risk preference, and the consequences for the optimization of stochastic dynamic models. A large literature in economics and finance (for example, all of asset pricing theory) optimizes the expected value of the present value of the utilities of intraperiod payoffs.  This talk explains why (a) that criterion is logically inconsistent, and (b) it is sometimes logically sound to use the criterion of the expected value of the utility of the present value of the intraperiod payoffs.  The talk briefly indicates the effects of applying the latter criterion to the standard dynamic newsvendor model and to a classical problem of optimal self-insurance.