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Once Upon a Time Preference - How Rationality and Risk Aversion Change the Rationale for Discounting

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  • Christian Traeger

Abstract

The paper develops an axiomatic framework for rational decision making. The von Neumann-Morgenstern axioms give rise to a richer risk attitude than that captured in the standard discounted expected utility model. I derive three models that permit a more comprehensive risk evaluation. These preference representations differ regarding the consistency requirements that are imposed in the evaluation of uncertain scenarios. Imposing all rationality constraints jointly eliminates pure time preference from economic evaluation. The resulting preference representation still gives reduced weight to expected future utility when uncertainty increases over time. The more we know about the future welfare consequences of our (in)actions, the more weight they receive. If uncertainty is endogenous to the decision process, the new rationale for discounting will yield quite different policy implications than the discounted expected utility model based on pure time preference.

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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3793.

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Date of creation: 2012
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Handle: RePEc:ces:ceswps:_3793

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Related research

Keywords: time preference; discounting; uncertainty; expected utility; recursive utility; risk aversion; intertemporal substitutability; stationarity; certainty additivity; temporal lotteries; intertemporal risk aversion; temporal resolution of risk; discount rate;

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References

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  1. Traeger, Christian P., 2010. "Intertemporal risk aversion – or – wouldn’t it be nice to tell whether Robinson Crusoe is risk averse?," CUDARE Working Paper Series 1102, University of California at Berkeley, Department of Agricultural and Resource Economics and Policy.
  2. Lars Peter Hansen & Thomas J. Sargent, 2007. "Introduction to Robustness," Introductory Chapters, Princeton University Press.
  3. Emi Nakamura & Jón Steinsson & Robert Barro & José Ursúa, 2013. "Crises and Recoveries in an Empirical Model of Consumption Disasters," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(3), pages 35-74, July.
  4. repec:ebl:ecbull:v:4:y:2007:i:29:p:1-8 is not listed on IDEAS
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Cited by:
  1. Adler, Matthew & Treich, Nicolas, 2014. "Consumption, Risk and Prioritarianism," TSE Working Papers 14-500, Toulouse School of Economics (TSE).

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