How Good is the Exponential Function Discounting Formula?: An Experimental Study

44 Pages Posted: 27 Jun 2003

See all articles by Uri Ben-Zion

Uri Ben-Zion

Technion-Israel Institute of Technology - The William Davidson Faculty of Industrial Engineering & Management; National Bureau of Economic Research (NBER)

Yochanan Shachmurove

City University of New York, CUNY City College of New York - Department of Economics; The University of Pennsylvania - Department of Economics

Joseph Yagil

University of Haifa - Graduate School of Business

Date Written: June 2003

Abstract

This paper estimates the degree of the exponential-function misvaluation, its variation with given product price level, and its expected growth rate. The paper examines whether other mathematical functions, such as linear, quadratic and cubic functions, conform to the discounting and compounding processes of individual decision makers. Using subjects familiar with the exponential function discounting formula, this study finds that individuals undervalue the compound interest discounting formula given by the exponential function and overvalue the simple interest discounting formula given by the linear function. These findings can be attributed to the overreaction, overconfidence, mental accounting and narrow-framing behaviors discussed in psychology.

Keywords: Exponential Discount Function, Experimental Subjective Discount Rates, Linear, Quadratic and Cubic Functions, Overreaction, Overconfidence, Mental Accounting and Narrow-Framing Behavior, Economic Psychology

JEL Classification: D90, G00

Suggested Citation

Ben-Zion, Uri and Shachmurove, Yochanan and Yagil, Yosef, How Good is the Exponential Function Discounting Formula?: An Experimental Study (June 2003). PIER Working Paper No. 03-015. Available at SSRN: https://ssrn.com/abstract=418581 or http://dx.doi.org/10.2139/ssrn.418581

Uri Ben-Zion

Technion-Israel Institute of Technology - The William Davidson Faculty of Industrial Engineering & Management ( email )

Haifa 32000
Israel
(972-4) 829-4432 (Phone)
(972-4) 829-5688 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Yochanan Shachmurove (Contact Author)

City University of New York, CUNY City College of New York - Department of Economics ( email )

160 Convent Avenue
New York, NY 10031
United States
212-650-6202 (Phone)

The University of Pennsylvania - Department of Economics ( email )

Ronald O. Perelman Center for Political Science
133 South 36th Street
Philadelphia, PA 19104-6297
United States
215-898-1090 (Phone)
215-573-2057 (Fax)

Yosef Yagil

University of Haifa - Graduate School of Business ( email )

Haifa 31905
Israel
972-4-240085 (Phone)
972-4-240059 (Fax)

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