Intertemporal Choice - SS200 Behavioural Economics

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Intertemporal Choice - SS200 Behavioural
Economics

• - 21 January 2004 by Martin Barner

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Papers

• Frederick, Loewenstein ODonoghue
• A review of intertemporal choice (2002)
• Angeletos, Laibson, Repetto, Tobacman
  Weinberg
• The hyperbolic consumption model (2001)
• Laibson
• Golden eggs and hyperbolic discounting (1997)

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Agenda

• Motivation
• History of intertemporal choice
• Anomalies from discounted utility theory
• Two examples of hyperbolic discounting
• Results of simulations in Angeletos et al
• Conclusions and perspectives

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Motivation

• What is analyzed
• Why care
• What to learn
• Citation

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History of intertemporal choice

• Adam Smith (1776)
• John Rae (1834)
• Eugen von Böhm-Bawerk (1889)
• Irving Fisher (1930)
• Paul Samuelson (1937)
• Robert Strotz (1956)
• Phelps and Pollak (1968)
• David Laibson (1994, 1997)

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Discounted Utility Model

• Discount rate expresses motives
• Accepted as normative and descriptive
• Utility and consumption independence
• Time consistency
• Opposing forces
• Diminishing marginal utility
• Positive time preference

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Definitions

• Time discounting
• Reason for caring less about future
• Time preference
• Immediate utility over delayed utility

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Anomalies from DU

• Empirically discount rates not constant
• Over time
• Across type of intertemporal choices
• Sign effect (gains vs. losses)
• Magnitude effect (small vs. large amounts)
• Sequence effect (sequence vs. singly)

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Figure 1 - from Frederick et al
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Figure 2 - from Frederick et al
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Hyperbolic discounting

• Declining rate of time preference

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Example 1

• Golden eggs and hyperbolic discounting
• Substancial benefit in long run
• But temptation in short run
• Illiquid assets provide commitment
• Two-thirds of American wealth illiquid
• Not counting human capital
• Access to credit reduce commitment
• Explain decline in savings rate 1980s

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Figure 3 - from Laibson
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Example 2

• The hyperbolic consumption model
• Long run intentions and short run actions
• Hyperbolic preferences induce dynamic
  inconsistency
• Sophisticated consumers
• Model with simulations

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Example 2 (continued)

• Model features
• uncertain future labour income
• liquidity constraint
• allow to borrow on credit cards - limit
• hyperbolic discounting implications
• labour income autocorrelated shocks
• hold liquid and illiquid assets
• Results

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Figure 4 - from Angeletos et al
,
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Figure 5 - from Angeletos et al
,
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Figure 6 - from Angeletos et al
,
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Figure 7 - from Angeletos et al
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Table 1 - from Angeletos et al
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Table 2 - from Angeletos et al
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Conclusion

• Use insight from psychology
• Relinguish finding the right discount rate
• Intertemporal choice reflects considerations
• Descriptively adequate models are not easy
• Not general theory degrees of freedom

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Behavioural perspectives

• Other models (instantaneous utility function)
• Habit formation
• Reference point models
• Visceral influence
• Projection bias
• Multiple self