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

See all articles by Thomas Epper

Thomas Epper

University of St. Gallen, School of Economics and Political Science; University of Zurich, Department of Economics

Helga Fehr-Duda

ETH Zürich - Center for Economic Research

Date Written: October 19, 2018

Abstract

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

Epper, Thomas and Fehr-Duda, Helga, The Missing Link: Unifying Risk Taking and Time Discounting (October 19, 2018). University of Zurich Department of Economics Working Paper No. 96, Revised version. Available at SSRN: https://ssrn.com/abstract=2175461 or http://dx.doi.org/10.2139/ssrn.2175461

Thomas Epper (Contact Author)

University of St. Gallen, School of Economics and Political Science ( email )

Varnbüelstrasse 19
St. Gallen, SG 9000
Switzerland

HOME PAGE: http://www.thomasepper.com

University of Zurich, Department of Economics ( email )

Blüemlisalpstrasse 10
Zuerich, 8006
Switzerland

Helga Fehr-Duda

ETH Zürich - Center for Economic Research ( email )

Weinbergstr. 35
Zurich 8092
Switzerland

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