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A Theory of Reference Time

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  • Ali al-Nowaihi

    ()

  • Sanjit Dhami

    ()

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    Abstract

    We consider a discounted utility model that has two components. (1) The instan- taneous utility is of the prospect theory form, thus, allowing for reference dependent outcomes. (2) The discount function embodies a ‘reference time’ to which all future outcomes are discounted back to, hence, the name, reference time theory. We allow the discount function to exhibit declining impatience, as in hyperbolic discounting models, subadditivity or both. We show that if the discount function is non-additive, then the presence of a reference time has important effects on intertemporal choices. For instance, this helps to explain apparently intransitive choices over time. We also show how several recent approaches to time discounting can be incorporated within our proposed framework; these include attribute models and models of uncertainty.

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    Bibliographic Info

    Paper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number 13/26.

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    Date of creation: Nov 2013
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    Handle: RePEc:lec:leecon:13/26

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    Related research

    Keywords: Discounted utility models; Reference time theory; Prospect theory; Hyperbolic discounting; Subadditive discounting.;

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    References

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    1. Laibson, David, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 443-77, May.
    2. Ali al-Nowaihi & Sanjit Dhami, 2005. "A simple derivation of Prelec’s probability weighting function," Discussion Papers in Economics 05/20, Department of Economics, University of Leicester.
    3. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March.
    4. Ali al-Nowaihi & Sanjit Dhami, 2005. "A Note On The Loewenstein-Prelec Theory Of Intertemporal Choice," Discussion Papers in Economics 05/18, Department of Economics, University of Leicester.
    5. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
    6. Ok, Efe A. & Masatlioglu, Yusufcan, 2007. "A theory of (relative) discounting," Journal of Economic Theory, Elsevier, vol. 137(1), pages 214-245, November.
    7. al-Nowaihi, Ali & Dhami, Sanjit, 2009. "A value function that explains the magnitude and sign effects," Economics Letters, Elsevier, vol. 105(3), pages 224-229, December.
    8. Ali al-Nowaihi & Sanjit Dhami, 2008. "A general theory of time discounting: The reference-time theory of intertemporal choice," Discussion Papers in Economics 08/22, Department of Economics, University of Leicester.
    9. Marc Scholten & Daniel Read, 2006. "Discounting by Intervals: A Generalized Model of Intertemporal Choice," Management Science, INFORMS, vol. 52(9), pages 1424-1436, September.
    10. Yoram Halevy, 2008. "Strotz Meets Allais: Diminishing Impatience and the Certainty Effect," American Economic Review, American Economic Association, vol. 98(3), pages 1145-62, June.
    11. Drazen Prelec, 1998. "The Probability Weighting Function," Econometrica, Econometric Society, vol. 66(3), pages 497-528, May.
    12. Read, Daniel, 2001. " Is Time-Discounting Hyperbolic or Subadditive?," Journal of Risk and Uncertainty, Springer, vol. 23(1), pages 5-32, July.
    13. George F. Loewenstein, 1988. "Frames of Mind in Intertemporal Choice," Management Science, INFORMS, vol. 34(2), pages 200-214, February.
    14. 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.
    15. Shane Frederick & George Loewenstein & Ted O'Donoghue, 2002. "Time Discounting and Time Preference: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 40(2), pages 351-401, June.
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