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Hyperbolic Discounting Is Rational: Valuing the Far Future with Uncertain Discount Rates

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Abstract

Conventional economics supposes that agents value the present vs. the future using an exponential discounting function. In contrast, experiments with animals and humans suggest that agents are better described as hyperbolic discounters, whose discount function decays much more slowly at large times, as a power law. This is generally regarded as being time inconsistent or irrational. We show that when agents cannot be sure of their own future one-period discount rates, then hyperbolic discounting can become rational and exponential discounting irrational. This has important implications for environmental economics, as it implies a much larger weight for the far future.

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Paper provided by Cowles Foundation for Research in Economics, Yale University in its series Cowles Foundation Discussion Papers with number 1719.

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Length: 17 pages
Date of creation: Aug 2009
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Handle: RePEc:cwl:cwldpp:1719

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Keywords: Hyperbolic discounting; Environment; Time consistent; Exponential discounting; Geometric random walk; Term structure of interest rates;

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  1. O'Donoghue, Ted & Rabin, Matthew, 1997. "Doing It Now or Later," Department of Economics, Working Paper Series qt7t44m5b0, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
  2. Newell, Richard G. & Pizer, William A., 2003. "Discounting the distant future: how much do uncertain rates increase valuations?," Journal of Environmental Economics and Management, Elsevier, vol. 46(1), pages 52-71, July.
  3. Loewenstein, George & Prelec, Drazen, 1992. "Anomalies in Intertemporal Choice: Evidence and an Interpretation," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 573-97, May.
  4. Tjalling C. Koopmans, 1959. "Stationary Ordinal Utility and Impatience," Cowles Foundation Discussion Papers 81, Cowles Foundation for Research in Economics, Yale University.
  5. Weitzman, Martin L., 1998. "Why the Far-Distant Future Should Be Discounted at Its Lowest Possible Rate," Journal of Environmental Economics and Management, Elsevier, vol. 36(3), pages 201-208, November.
  6. Ho, Thomas S Y & Lee, Sang-bin, 1986. " Term Structure Movements and Pricing Interest Rate Contingent Claims," Journal of Finance, American Finance Association, vol. 41(5), pages 1011-29, December.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Is hyperbolic discounting rational?
    by Economic Logician in Economic Logic on 2009-09-21 14:54:00
  2. The sickness of short-term-ism -- it's everywhere
    by Mark Buchanan in The Physics of Finance on 2011-07-06 12:36:00
  3. Deep Discounting Errors?
    by Mark Buchanan in The Physics of Finance on 2011-05-28 10:42:00
Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
Cited by:
  1. Gaël Giraud & Céline Rochon, 2010. "Transition to Equilibrium in International Trades," Documents de travail du Centre d'Economie de la Sorbonne 10012, Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne.
  2. Gaël Giraud & Céline Rochon, 2010. "Transition to Equilibrium in International Trades," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00657038, HAL.
  3. Eric Crampton & Matt Burgess & Brad Taylor, 2011. "The Cost of Cost Studies," Working Papers in Economics 11/29, University of Canterbury, Department of Economics and Finance.
  4. Boyarchenko, Svetlana & Levendorskii, Sergei, 2010. "Discounting when income is stochastic and climate change policies," MPRA Paper 27998, University Library of Munich, Germany.

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