Failure of Smooth Pasting Principle and Nonexistence of Equilibrium Stopping Rules under Time-Inconsistency
23 Pages Posted: 19 Jul 2018
Date Written: June 26, 2018
This paper considers a time-inconsistent stopping problem in which the inconsistency arises from non-constant time preference rates. We show that the smooth pasting principle, the main approach that has been used to construct explicit solutions for conventional time-consistent optimal stopping problems, may fail under time-inconsistency. Specifically, we prove that the smooth pasting principle solves a time-inconsistent problem within the intra-personal game theoretic framework if and only if a certain inequality on the model primitives is satisfied. We show that the violation of this inequality can happen even for very simple non-exponential discount functions. Moreover, we demonstrate that the stopping problem does not admit any intra-personal equilibrium whenever the smooth pasting principle fails. The "negative" results in this paper caution blindly extending the classical approaches for time-consistent stopping problems to their time-inconsistent counterparts.
Keywords: time inconsistency, equilibrium stopping rule, intra-personal game, smooth pasting, nonexistence
JEL Classification: D81, D90, G11
Suggested Citation: Suggested Citation