Let U be concave and strictly increasing, and let A be a vector space of random variables. For every random variable Z let
F(Z)=X∈AsupE[U(X+Z)]
and suppose there exists a random variable XZ∈A such that
F(Z)=E[U(XZ+Z)]
For a random variable Y, let π(Y) be such that F(Y−π(Y))=F(0).
(a) Show that for every constant a we have π(Y+a)=π(Y)+a, and that if P(Y1⩽Y2)=1, then π(Y1)⩽π(Y2). Hence show that if P(a⩽Y⩽b)=1 for constants a⩽b, then a⩽π(Y)⩽b.
(b) Show that Y↦π(Y) is concave, and hence show t↦π(tY)/t is decreasing for t>0.
(c) Assuming U is continuously differentiable, show that π(tY)/t converges as t→0, and that there exists a random variable X0 such that
t→0limtπ(tY)=E[U′(X0)]E[U′(X0)Y]