DOCSLIB.ORG

Homo Economicus Is Stochastically Patient

Total Page：16

File Type：pdf, Size：1020Kb

Download full-text PDF Read full-text
Homo Economicus Is Stochastically Patient Homo Economicus is Stochastically Patient Eric R. Ulm, Daniel Bauer, Justin Sydnor∗ July 2020 Abstract DeJarnette et al. (2020) introduce the concept of generalized expected discounted utility (GEDU) and show that it can explain the empirical finding that people tend to be risk-averse over time lotteries but violates an intuitively appealing property they call stochastic impatience. This note extends their analysis to the classical case of an agent that maximizes expected utility of future consumption subject to a budget constraint. We show that these classical agents ad- here to GEDU preferences with risk aversion over time lotteries and will often be stochastically patient. We argue that while stochastic impatience may be an intuitively appealing criterion when lottery payouts map directly to concurrent utility experiences, when agents can save, bor- row, and optimize, stochastic patience is a natural result. We present results of a simple survey experiment consistent with this view, finding that individuals exhibit stochastic impatience for small-scale monetary risks but stochastic patience for large-scale risks. JEL classification: D81; D90; C91. Keywords: Risk and Time Preferences, Stochastic Impatience, Expected Consumption Utility. Introduction DeJarnette et al. (2020) advance our understanding of consumers’ preferences across risk and time by analyzing time lotteries. As one of their key results, they show that under Expected Discounted Utility (EDU), individuals must be risk-seeking over time lotteries (RSTL). Yet their experimental results show that the majority of people are risk-averse over time lotteries (RATL). They show that a modification of EDU they call Generalized EDU (GEDU) can account for this risk aversion over time lotteries. However, they highlight that a necessary sacrifice for overcoming RSTL is to accept that individuals violate an intuitively appealing property they call stochastic impatience, ∗Ulm: School of Economics and Finance, Victoria University of Wellington, 23 Lambton Quay Wellington, NZ, [email protected]. Bauer/Sydnor: Department of Risk and Insurance, University of Wisconsin-Madison, 975 Uni- versity Avenue, Madison, WI 53706, USA, [email protected]/[email protected]. 1 HOMO ECONOMICUS IS STOCHASTICALLY PATIENT 2 the “risky counterpart to the standard notion of Impatience” that individuals “should [behave] in accordance with” (p. 621). They show that this incompatibility plagues a broad class of models, including many forms of non-expected utility and time discounting. Ultimately, they conclude that their results call into question some of the foundations of the models that are core to many applied economics insights. In the EDU framework and related models that are the focus of DeJarnette et al. (2020), lottery payouts at a moment in time map directly to utility realizations at that time. This framework is likely the relevant approach for situations where risk and time delays are over direct consump- tion experiences that cannot be reallocated or reoptimized over time. It may also be the right as if approximation for psychological reactions to small dollar rewards at different points in time. However, in many economic applications the dominant modeling approach is intertemporal maxi- mization of consumption utility subject to a budget constraint so that it is probably inappropriate to consider EDU as the “standard model in economics” as DeJarnette et al. claim (Frederick, Loewen- stein, and O’donoghue, 2002; Cohen el al., 2020, and references therein). In models of intertem- poral consumption utility, individuals reoptimize consumption streams in reaction to stochastic monetary realizations and this has important implications for how to think about reactions to risky lotteries over time. In this note we show that when extending the DeJarnette et al. analysis to this classical case of an agent who maximizes utility over consumption subject to an intertemporal budget constraint, there is nothing problematic about the inconsistency between risk aversion over time lotteries and stochastic impatience. We show theoretically that agents maximizing intertemporal utility of con- sumption will adhere to DeJarnette et al.’s Generalized EDU preferences in the context they con- sider, albeit with specific parameter choices. They will (thus) often display risk aversion over time lotteries. Moreover, these classical agents will – and should – violate stochastic impatience as long as they are sufficiently risk-averse. Stochastic patience, rather than stochastic impatience, is the natural result in this classical model of intertemporally maximized consumption utility. To provide intuition for our arguments, it is helpful to revisit one of the examples DeJarnette et al. present to showcase stochastic impatience (p. 627): • Lottery A: (50-50) $100 today or $20 in one month. • Lottery B: (50-50) $20 today or $100 in one month. Stochastic impatience implies that agents prefer the larger prize earlier, so that Lottery A will be preferred. This seems to an intuitively appealing criterion when the monetary prizes map directly to utility received at that time. If I can have either utility of $100 or $20 and that utility will arise either today or in one month, preferring the higher utility earlier is intuitive. HOMO ECONOMICUS IS STOCHASTICALLY PATIENT 3 However, for an agent that is optimizing consumption utility over time, when they learn which monetary prize they are receiving, they will smooth consumption and allocate part of that prize to both time periods. Prizes received later have a lower present-discounted value than prizes received earlier and result in lower utility in both periods. That reduction in utility from the later receipt of the prize has a bigger effect when the overall level of consumption is lower. As a result, a sufficiently risk-averse person anticipating smoothing consumption will not prefer lotteries where low wealth positively correlates with later receipt of the wealth. Instead they prefer diversification, where better wealth realizations correlate with more delay.1 That is, they will be stochastically patient. This intuition can be made more transparent by recasting DeJarnette et al.’s example into a naturalistic situation with larger stakes and income received over time, where consumption utility maximization is likely more intuitive. Consider the following example where a currently unem- ployed person (e.g., a new college graduate) has two potential jobs they might land with very different annual salaries and the potential for a delayed start: • Lottery A’: (50-50) $100,000 starting right away or $50,000 with 6 months wait to start. • Lottery B’: (50-50) $50,000 starting right away or $100,000 with 6 months wait to start. We suspect that for most people in this formulation, Lottery B’ – the stochastically patient option – is more naturally appealing.2 To test that intuition, we conducted a simple pre-registered survey experiment on Amazon’s Mechanical Turk platform with 162 participants. We randomized participants to choose between either Lotteries A/B (DeJarnette et al.’s small-dollar choice) or Lotteries A’/B’ (our large-stakes choice), with both being hypothetical choices. Consistent with DeJarnette et al.’s conjecture that stochastic impatience is an intuitive property for their lottery, 68 percent of subjects made the stochastically impatient choice of Lottery A over Lottery B. However, in the larger-stakes option, the majority of subjects (57 percent) instead made the stochastically patient choice of Lottery B’ over Lottery A’. Overall, the results of our theoretical analysis and this supplementary experiment suggest that violations of stochastic impatience are natural in environments where people are likely to optimize in response to stochastic realizations. More generally, these results call for nuance in interpreting 1We show that the intuition for this result can be illustrated using familiar insights from financial asset pricing theory by decomposing DeJarnette et al.’s stochastic impatience lotteries into an identical background lottery and differing supplemental lotteries. 2The optimal consumption streams will diverge more between realizations in Lottery A’ than Lottery B’: Note that the two lotteries are equivalent after the first year and therefore someone who is smoothing consumption might focus on the total income differences over the first year; Lottery A’ involves a total of either $100,000 or $25,000 in income during the first year while Lottery B’ guarantees a certain level of $50,000 income during the first year. HOMO ECONOMICUS IS STOCHASTICALLY PATIENT 4 the implications of DeJarnette et al. (2020). Their analysis suggests the need to reconsider the EDU model and its close cousins. Yet there is little reason to believe these concerns are an issue for economic analysis in environments when people save and optimize, where models of intertemporal consumption utility maximization subject to budget constraints are the norm. In order to keep the discussion that follows transparent and accessible, we first describe our analysis of DeJarnette et al.’s simple lotteries in a setting with two pay-out days, simple preferences with a constant relative risk aversion/elasticity of intertemporal substitution, and their motivating example in favor of stochastic impatience (p. 627). However, we also provide results that document the general validity of our main points (with proofs relegated to an online appendix). Utility of Intertemporally Optimized Consumption and GEDU
Load more

Recommended publications
  • Intertemporal Consumption and Savings Behavior: Neoclassical, Behavioral, and Neuroeconomic Approaches
    Intertemporal Consumption and Savings Behavior: Neoclassical, Behavioral, and Neuroeconomic Approaches Joshua J. Kim June 2014 Abstract This paper summarizes neoclassical, behavioral, and neuroeconomic models of intertemporal consumption and savings behavior. I summarize the construction and implications of Modigliani & Brumberg's Life-Cycle Hypothesis [4] and Laibson's quasi-hyperbolic consumption function [8] as background and motivation for Bisin & Benhabib's neuroeconomic model of dynamic consumption behavior [3]. In particular, I focus on the mathe- matical construction of each model, their different behavioral assumptions of agent rationality, and the resulting implications for economic theory. 1 The Neoclassical Life-Cycle Hypothesis The development of modern economic theories analyzing intertemporal consumption began in the early 1950s with the publication of Modigliani & Brumberg's Life-cycle Hypothesis (LCH) [4]. By making several arguably innocuous assumptions, Modigliani & Brumberg produce several important and non-trival predictions about macroeconomic processes such as the relationship in aggregate economics between savings and growth. Furthermore, since its construction, the LCH has served as the standard economic approach to the study of consumption and savings behavior and has served as a foundational basis for subsequent models of intertemporal consumption. The structure of the rest of this chapter is as follows: subsection 1.1 presents the theoretical foundations and assumptions of the LCH. Subsection 1.2 discusses some of the implications and results. Subsection 1.3 concludes the discussion on neoclassical models of intertemporal consumption and discusses several objections and limitations of the LCH. 1 1.1 Theoretical Foundations Before we begin the construction of the life-cycle hypothesis, let us first define a few terms that readers unfamiliar with economic theory may not know.
    [Show full text]
  • Variable-Time-Preference-He-Et-Al.Pdf
    Cognitive Psychology 111 (2019) 53–79 Contents lists available at ScienceDirect Cognitive Psychology journal homepage: www.elsevier.com/locate/cogpsych Variable time preference ⁎ T Lisheng Hea, , Russell Golmanb, Sudeep Bhatiaa,1 a University of Pennsylvania, United States b Carnegie Mellon University, United States ARTICLE INFO ABSTRACT Keywords: We re-examine behavioral patterns of intertemporal choice with recognition that time pre- Decision making ferences may be inherently variable, focusing in particular on the explanatory power of an ex- Intertemporal choice ponential discounting model with variable discount factors – the variable exponential model. We Stochastic choice provide analytical results showing that this model can generate systematically different choice Preference variability patterns from an exponential discounting model with a fixed discount factor. The variable ex- Computational modeling ponential model accounts for the common behavioral pattern of decreasing impatience, which is typically attributed to hyperbolic discounting. The variable exponential model also generates violations of strong stochastic transitivity in choices involving intertemporal dominance. We present the results of two experiments designed to evaluate the variable exponential model in terms of quantitative fit to individual-level choice data. Data from these experiments reveal that allowing for a variable discount factor significantly improves the fit of the exponential model, and that a variable exponential model provides a better account of individual-level choice probabilities than hyperbolic discounting models. In a third experiment we find evidence of strong stochastic transitivity violations when intertemporal dominance is involved, in accordance with the variable exponential model. Overall, our analytical and experimental results indicate that exponential discounting can explain intertemporal choice behavior that was supposed to be beyond its descriptive scope if the discount factor is permitted to vary at random.
    [Show full text]
  • Notes on the Economics of Household Energy Consumption and Technology Choice
    Notes on the Economics of Household Energy Consumption and Technology Choice Alan H. Sanstad* Lawrence Berkeley National Laboratory Abstract The Office of Management and Budget (OMB) and the Department of Energy (DOE) have initiated a joint effort to examine the issue of consumer welfare impacts of appliance energy efficiency standards, and to extend and discuss enhancements to the methodology by which these impacts are defined and estimated in the regulatory process. DOE's economic analysis of efficiency standards generally takes a life-cycle cost investment perspective focused on the trade- off between initial and operating costs for efficient equipment. In this perspective, the time value-of-money is represented by the cost of capital. In a more general framework, additional trade-offs exist between investment and consumption, and consumer choice over the planning horizon also reflects preferences for future consumption. In this framework, these preferences combine with the cost-of-capital as drivers of consumer choice. This document presents a first version of a mathematical framework for analyzing the similarities and differences between these two decision modeling approaches, and thus starts to address several theoretical economic issues raised by OMB. It is anticipated that further elaboration of this framework may support empirical analysis to develop practical quantitative tools for improved assessment of the effects of appliance standards. * Staff Scientist, Lawrence Berkeley National Laboratory. #1 Cyclotron Rd., Berkeley, CA 94720. Voice: 510-486-6433; Fax: 510-486-6996; e-mail: [email protected]. 1. Introduction U. S. federal appliance energy efficiency standards are established using a set of criteria pertaining to their effects on industry, consumers, environmental quality, and other factors.
    [Show full text]
  • Neuroeconomic Studies of Impulsivity: Now Or Just As Soon As Possible?
    University of Pennsylvania ScholarlyCommons Departmental Papers (Psychology) Department of Psychology 5-2-2007 Neuroeconomic Studies of Impulsivity: Now or Just as Soon as Possible? Paul W. Glimcher New York University Joseph W. Kable University of Pennsylvania, [email protected] Kenway Louie New York University Follow this and additional works at: https://repository.upenn.edu/psychology_papers Part of the Psychology Commons Recommended Citation Glimcher, P. W., Kable, J. W., & Louie, K. (2007). Neuroeconomic Studies of Impulsivity: Now or Just as Soon as Possible?. American Economic Review, 97 (2), 142-147. http://dx.doi.org/10.1257/aer.97.2.142 This paper is posted at ScholarlyCommons. https://repository.upenn.edu/psychology_papers/30 For more information, please contact [email protected]. Neuroeconomic Studies of Impulsivity: Now or Just as Soon as Possible? Abstract Existing behavioral studies of intertemporal choice suggest that both human and animal choosers are impulsive. One possible explanation for this is that they discount future gains in a hyperbolic or quasi- hyperbolic fashion (David I. Laibson 1997; Shane Frederick, George Loewenstein, and Ted O’Donoghue 2002). This observation stands in contrast to standard normative theory, which predicts exponential discounting for any single maximizing agent (Robert H. Strotz 1956). This disparity between empirical and normative approaches is typically explained by proposing that human choosers suffer from inner conflict, balancing an impulse for an immediate gratification against other forces calling for delayed gratification (Richard H. Thaler and H. M. Shefrin 1981; Laibson 1997; Drew Fudenberg and David K. Levine 2006; Jess Benhabib and Alberto Bisin 2005; B. Douglas Bernheim and Antonio Rangel 2004; Faruk Gul and Wolfgang Pesendorfer 2001).
    [Show full text]
  • Measuring Time Preferences
    NBER WORKING PAPER SERIES MEASURING TIME PREFERENCES Jonathan D. Cohen Keith Marzilli Ericson David Laibson John Myles White Working Paper 22455 http://www.nber.org/papers/w22455 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 July 2016 We thank Steven Durlauf and five anonymous referees at the Journal of Economic Literature for thoughtful comments. We thank Layne Kirshon, Omeed Maghzian, Lea Nagel, and Kartik Vira for outstanding research assistance. We acknowledge financial support from the National Institutes of Health (NIA R01AG021650 and P01AG005842) and the Pershing Square Fund for Research in the Foundations of Human Behavior. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. NBER working papers are circulated for discussion and comment purposes. They have not been peer- reviewed or been subject to the review by the NBER Board of Directors that accompanies official NBER publications. © 2016 by Jonathan D. Cohen, Keith Marzilli Ericson, David Laibson, and John Myles White. All rights reserved. Short sections of text, not to exceed two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given to the source. Measuring Time Preferences Jonathan D. Cohen, Keith Marzilli Ericson, David Laibson, and John Myles White NBER Working Paper No. 22455 July 2016, Revised February 2019 JEL No. D03,D9 ABSTRACT We review research that measures time preferences—i.e., preferences over intertemporal tradeoffs. We distinguish between studies using financial flows, which we call “money earlier or later” (MEL) decisions and studies that use time-dated consumption/effort.
    [Show full text]
  • Rethinking Economic Modelling: the Case for Behavioural Economics
    BEHAVIOURAL ECONOMICS Rethinking Economic Modelling: the Case for Behavioural Economics Pierre-Louis Boczmak, Senior Sophister The concept of Economic Man has been at the heart of economics since its early days. In this essay, Pierre Louis Boczmak assesses two models based on this precept; Ex- pected Utility and Discounted Utility using Stigler’s three criteria for a sound economic model: empirical accuracy, generality, and tractability. This essay also presents two alternative models offered by behavioural economist who deviate from the assumption of Homo Economicus. This essay then concludes that the be- havioural models, Prospect Theory and Hyperbolic dis- counting take into account the limitations of Economic Man and improve the empirical accuracy of economic models without significantly impacting the other two criteria. However, much work is still needed in mod- eling the insights of behavioural economics before the discipline can move away from the concept of Economic Man. INTRODUCTION large body of research has identified the relations between countries as well A as internal social and political order as being strongly determined by eco- nomic prosperity, itself overwhelmingly associated with market economy. Thus, bettering our understanding of today’s market economy could yield a wide range of benefits in the future. This essay shall therefore be concerned with the use- 85 STUDENT ECONOMIC REVIEW VOL. XXXIII fulness of the concept of Economic Man for theorising and modelling today’s economy, and, by extension, the assessment of those models which make use of the concept. For this purpose, this paper will not be investigating the concept’s usefulness from a philosophical and sociological standpoint, and recognises that real people’s actions are much more complex than what the Economic Man con- cept allows for.
    [Show full text]
  • A New Approach to Intertemporal Choice: the Delay Function
    S S symmetry Article A New Approach to Intertemporal Choice: The Delay Function Salvador Cruz Rambaud * and Isabel González Fernández Departamento de Economía y Empresa, Universidad de Almería, La Cañada de San Urbano, s/n, 04120 Almería, Spain; [email protected] * Correspondence: [email protected]; Tel.: +34-950-015-184 Received: 14 April 2020; Accepted: 10 May 2020; Published: 13 May 2020 Abstract: The framework of this paper is intertemporal choice, which traditionally has been studied with preference relations and discount functions. However, the interest of econophysics in this topic makes time become a central magnitude. Therefore, the aim of this paper is to introduce the concept of delay function and, by using this tool, to analyze the concept of impatience and the different types of inconsistency. In behavioral finance, consistency is correlated with the concept of symmetry because, in this case, the indifference between two rewards does not change when the same delay is added to their respective availability dates. Moreover, we have shown the way to derive a discount (respectively, delay) function starting from the expression of its corresponding delay (respectively, discount) function by requiring some suitable conditions for this construction. Finally, we have deduced the concept of instantaneous variation rate and Prelec’s measure of inconsistency in terms of the delay function. Keywords: econophysics; intertemporal choice; delay function; inconsistency; increasing impatience; moderately decreasing impatience; strongly decreasing impatience JEL Classification: C91; D81; D99 1. Introduction Intertemporal choice involves making decisions between several alternatives whose monetary amounts take place at different instants of time. From the point of view of economics, Samuelson [1] carried out the first study on intertemporal choice when introducing the so-called Discounted Utility (DU) model.
    [Show full text]
  • Neuroeconomics: Cross-Currents in Research on Decision-Making
    Review TRENDS in Cognitive Sciences Vol.10 No.3 March 2006 Neuroeconomics: cross-currents in research on decision-making Alan G. Sanfey1, George Loewenstein2, Samuel M. McClure3 and Jonathan D. Cohen3 1Department of Psychology, University of Arizona, Tucson, AZ 85721, USA 2Department of Social and Decision Sciences, Carnegie Mellon University, Pittsburgh, PA 15213, USA 3Department of Psychology, and Center for the Study of Brain, Mind and Behavior, Princeton University, Princeton, NJ 08544, USA Despite substantial advances, the question of how we Although we are perhaps not as optimistic as the most make decisions and judgments continues to pose ardent believers in neuroeconomics when it comes to the important challenges for scientific research. Historically, time-line of progress, we do believe that the field has real different disciplines have approached this problem using potential for making important contributions to our different techniques and assumptions, with few unifying understanding of decision-making, above and beyond efforts made. However, the field of neuroeconomics has what has and will continue to be learned from work recently emerged as an inter-disciplinary effort to bridge within each discipline independently. This is because this gap. Research in neuroscience and psychology has neuroeconomics is able to draw upon the complementary begun to investigate neural bases of decision predict- strengths of its contributing disciplines. In fact, the ability and value, central parameters in the economic benefits of increasing contact between neuroscience, theory of expected utility. Economics, in turn, is being psychology and economics are already apparent. increasingly influenced by a multiple-systems approach The central argument of this article is that economics, to decision-making, a perspective strongly rooted in psychology and neuroscience can each benefit from taking psychology and neuroscience.
    [Show full text]
  • Akratic Homo Economicus: Does the Neoclassical Economic Theory "Rational Agent" Assumption Accurately Depict Human Nature?
    University of Denver Digital Commons @ DU Electronic Theses and Dissertations Graduate Studies 1-1-2016 Akratic Homo Economicus: Does the Neoclassical Economic Theory "Rational Agent" Assumption Accurately Depict Human Nature? Marina Logachev University of Denver Follow this and additional works at: https://digitalcommons.du.edu/etd Part of the Economic Theory Commons Recommended Citation Logachev, Marina, "Akratic Homo Economicus: Does the Neoclassical Economic Theory "Rational Agent" Assumption Accurately Depict Human Nature?" (2016). Electronic Theses and Dissertations. 1098. https://digitalcommons.du.edu/etd/1098 This Thesis is brought to you for free and open access by the Graduate Studies at Digital Commons @ DU. It has been accepted for inclusion in Electronic Theses and Dissertations by an authorized administrator of Digital Commons @ DU. For more information, please contact [email protected],[email protected]. Akratic Homo Economicus: Does the Neoclassical Economic Theory “Rational Agent” Assumption Accurately Depict Human Nature? __________ A Thesis Presented to the Faculty of Social Sciences University of Denver __________ In Partial Fulfillment of the Requirements for the Degree Master of Arts __________ by Marina Logachev March 2016 Advisor: Dr. Tracy Mott ©Copyright by Marina Logachev 2016 All Rights Reserved Author: Marina Logachev Title: AKRATIC HOMO ECONOMICUS: DOES THE NEOCLASSICAL ECONOMIC THEORY “RATIONAL AGENT” ASSUMPTION ACCURATELY DEPICT HUMAN NATURE? Advisor: Dr. Tracy Mott Degree Date: March 2016 Abstract Neoclassical economic theory has long been scrutinized for its failure to be congruent with reality, often lacking generality and tractability due to, what many critics argue to be, unrealistic assumptions. One of the theory’s core suppositions is a representative “rational agent” or homo economicus, whose self-interest and optimal choices, which are in state of equilibrium and efficiency are rooted in utility maximization of his well-being.
    [Show full text]
  • The Normative Standard for Future Discounting
    The Normative Standard for Future Discounting Craig Callender December 13, 2018 1Introduction Decisions are typically about outcomes that happen later in time. As such they demand comparisons of the value of outcomes now versus outcomes later. Should I buy a new car or save for retirement? Have the last piece of cake tonight or tomorrow? Lower carbon emissions now or suffer greater loss later? Intertemporal decisions have triggered hundreds of studies across many fields. Popular subjects include personal finances, ad- diction, nutrition, health, marketing, and environmental conservation. In many of these decisions we tend to exhibit what is called a positive time preference; that is, all else being equal, we prefer positive goods, experiences, and states of affairs to be delivered sooner rather than later. Sweets delivered to me tomorrow aren’t as valuable to me as sweets I can eat today. Descriptive and normative inquiries tackle how we make intertemporal comparisons of utility in such cases and how we should. The present paper is about the second issue, the normative question that asks how we ought to translate future utility into present utility. My focus is restricted to individuals and not societies. I want to chal- lenge the conventional wisdom dominating the social sciences and philosophy regarding temporal discounting, the practice of discounting the value of future utility. Although economists, psychologists and philosophers often sharply disagree on tempo- ral discounting, there is a common picture that many will recognize. Call it the Standard Model. It begins with a normative standard. That standard demands that insofar as one is rational one discounts utilities at future times with an exponential discount function.
    [Show full text]
  • Kalenscher Pennartz 2008.Pdf
    Progress in Neurobiology 84 (2008) 284–315 www.elsevier.com/locate/pneurobio Is a bird in the hand worth two in the future? The neuroeconomics of intertemporal decision-making Tobias Kalenscher *, Cyriel M.A. Pennartz Animal Physiology and Cognitive Neuroscience, Swammerdam Institute for Life Sciences, Faculty of Science, University of Amsterdam, Kruislaan 320, 1098 SM Amsterdam, The Netherlands Received 3 May 2007; received in revised form 28 November 2007; accepted 29 November 2007 Abstract When making intertemporal decisions, i.e., decisions between outcomes occurring at different instants in time, humans and animals prefer rewards with short-term availability over rewards that become available in the long run. Discounted utility theory (DUT) is an influential normative model for intertemporal decisions that attempts to capture preference over time. It prescribes which is the best decision to takewith respect to consistent, coherent and optimal choice. Over the last few decades, DUT’s descriptive validity has been critically challenged. Empirical studies found systematic violations of several of DUT’s assumptions, including time-consistency of preferences, stationarity,constant discounting and utility maximisation. To account for theseanomalies,alternativemodelshavebeendevisedinvariousacademicdisciplines,includingeconomics,psychology,biology,philosophy,andmost lately, cognitive neuroscience. This article reviews the most recent literature on the behavioural and neural processes underlying intertemporal choices, and elucidates to which extent these findings can be used to explainviolations of DUT’s assumptions. In the first three sections, DUT is introduced, and behavioural anomalies are discussed. The fourth part focuses on the neuroscience of intertemporal choice, including its functional neuroanatomy, attempts to find a discounted value signal in the brain, and recent efforts to identify neural mechanisms producing time-inconsistencies.
    [Show full text]
  • Modeling Alternatives to Exponential Discounting
    Munich Personal RePEc Archive Modeling Alternatives to Exponential Discounting Musau, Andrew University of Agder 2 June 2009 Online at https://mpra.ub.uni-muenchen.de/16416/ MPRA Paper No. 16416, posted 23 Jul 2009 06:10 UTC Modeling Alternatives to Exponential Discounting Andrew Musau University of Agder Faculty of Economics and Social Sciences 2009 Abstract One area that is often overlooked by economists and social scientists is dis- counting. Most economic models of intertemporal choice make use of Samuel- son’s (1937) DU model which leads to an exponential discount function. Diver- gences from what economic modelling predicts and empirical findings are on the most part attributed to factors other than the discount function employed. We review the literature on the DU model and identify its behavioral anomalies. We look into suggested quasi-hyperbolic and hyperbolic models that in part ac- count for these anomalies. We analyze an infinite IPD game and demonstrate that under quasi-hyperbolic discounting, cooperation emerges as an SPE at a higher level of the discount factor. We further demonstrate that the unemploy- ment equilibrium in the Shapiro & Stiglitz (1984) Shirking model is not static under both hyperbolic and quasi-hyperbolic discounting. Keywords: intertemporal, exponential, quasi-hyperbolic, hyperbolic. 1 Introduction Economic decision making involves an analysis of expected payoffs over some time period. Hence, a critical issue that arises is what value an agent assigns to the present relative to the future and the tradeoffs she makes between near-term payoffs and payoffs that are far into the future. Decisions regarding the timing of a firm’s entry into a new market, for example, are based on the tradeoffs between the value of waiting and the benefits from moving quickly.
    [Show full text]