A Theory of Endogenous Time Preference, and Discounted Utility Anomalies
33 Pages Posted: 20 Feb 2005
Date Written: February 18, 2005
We explain essentially all known discounted utility anomalies as artefacts of the optimizing behavior of an individual with a time-separable utility function, who perceives a good as a source of a stochastic consumption stream, and believes that she can wait for an optimal moment to buy or sell the good. For this individual, the fair price of the corresponding utility stream is interpreted as an integral of a deterministic utility stream multiplied by certain non-exponential factors which we interpret as endogenous discount factors; the factors are different for gains and losses, and depend on the utility function and underlying uncertainty. We provide analytic expressions and numerical examples for discount factors assuming simple utility functions and gaussian uncertainty.
Keywords: Time preference, discounted utility anomalies, decision-making under uncertainty, optimal stopping
JEL Classification: D81, D91, C61, G31
Suggested Citation: Suggested Citation