The Missing Link: Unifying Risk Taking and Time Discounting
University of Zurich Department of Economics Working Paper No. 96, Revised version
70 Pages Posted: 15 Nov 2012 Last revised: 16 Nov 2018
Date Written: October 19, 2018
Standard economic models view risk taking and time discounting as two independent dimensions of decision makers' behavior. However, mounting experimental evidence demonstrates the existence of robust and systematic interaction effects. There are striking parallels in patterns of risk taking and time discounting behavior, which suggests that there is a common underlying force driving these interactions. Here we show that decision makers' anticipation of something going wrong in the future conjointly with their proneness to probability weighting generates a unifying framework for explaining seven puzzling regularities: delay-dependent risk tolerance, aversion to sequential resolution of uncertainty, preferences for resolution timing, hyperbolic discounting, subadditive discounting, the differential discounting of risky and certain outcomes, and the order dependence of prospect valuation. Finally, we discuss the implications of our framework for understanding real-world behavior, such as the coexistence of underinsuring and overinsuring.
Keywords: risk taking, time discounting, probability weighting, decreasing impatience, increasing risk tolerance, preference for late resolution of uncertainty, preference for one-shot resolution of uncertainty
JEL Classification: D01, D81, D91
Suggested Citation: Suggested Citation