Microfoundations of Discounting

Alexander T. I. Adamou, Yonatan Berman, Diomides P. Mavroyiannis and Ole Peters

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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.

Date: 2019-10, Revised 2020-01
New Economics Papers: this item is included in nep-evo and nep-upt
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Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1910.02137

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