Once Upon a Time Preference - How Rationality and Risk Aversion Change the Rationale for Discounting
AbstractThe 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 InfoPaper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3793.
Date of creation: 2012
Date of revision:
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;
Find related papers by JEL classification:
- D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
- D60 - Microeconomics - - Welfare Economics - - - General
- D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
- D91 - Microeconomics - - Intertemporal Choice - - - Intertemporal Household Choice; Life Cycle Models and Saving
- H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
- Q01 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - General - - - Sustainable Development
- Q51 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Valuation of Environmental Effects
- Q54 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Environmental Economics - - - Climate; Natural Disasters
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