Microfoundations of Discounting

22 Pages Posted: 12 Dec 2019

See all articles by Alexander Adamou

Alexander Adamou

London Mathematical Laboratory

Yonatan Berman

London Mathematical Laboratory

Diomides Mavroyiannis

affiliation not provided to SSRN

Ole Peters

London Mathematical Laboratory; Santa Fe Institute

Date Written: October 2, 2019

Abstract

An important question in economics is how people choose between different payments in the future. The classical normative model predicts that a decision maker discounts a later payment relative to an earlier one by an exponential function of the time between them. Descriptive models use non-exponential functions to fit observed behavioral phenomena, such as preference reversal. Here we propose a model of discounting, consistent with standard axioms of choice, in which decision makers maximize the growth rate of their wealth. Four specifications of the model produce four forms of discounting - no discounting, exponential, hyperbolic, and a hybrid of exponential and hyperbolic - two of which predict preference reversal. Our model requires no assumption of behavioral bias or payment risk.

Keywords: decision theory, temporal discounting, ergodicity economics

JEL Classification: D8, D9

Suggested Citation

Adamou, Alexander and Berman, Yonatan and Mavroyiannis, Diomides and Peters, Ole, Microfoundations of Discounting (October 2, 2019). Available at SSRN: https://ssrn.com/abstract=3463229 or http://dx.doi.org/10.2139/ssrn.3463229

Alexander Adamou

London Mathematical Laboratory ( email )

14 Buckingham St
London, WC2N 6DF
United Kingdom

Yonatan Berman (Contact Author)

London Mathematical Laboratory

8 Margravine Gardens
London, London W6 8RH
United Kingdom

Diomides Mavroyiannis

affiliation not provided to SSRN

Ole Peters

London Mathematical Laboratory ( email )

14 Buckingham St
London, WC2N 6DF
United Kingdom

Santa Fe Institute ( email )

1399 Hyde Park Road
Santa Fe, NM 87501
United States

HOME PAGE: http://tuvalu.santafe.edu/~ole/

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