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A theory of endogenous time preference, and discounted utility anomalies

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Author Info
Svetlana Boyarchenko (The University of Texas at Austin)
Sergei Levendorskii (The University of Texas at Austin)

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Abstract

We explain essentially all known discounted utility anomalies as artefacts of the optimizing behavior of an individual with a time- separable utility function, who perceives a good as a source of a stochastic consumption stream, and believes that she can wait for an optimal moment to buy or sell the good. For this individual, the fair price of the corresponding utility stream is interpreted as an integral of a deterministic utility stream multiplied by certain non-exponential factors which we interpret as endogenous discount factors; the factors are different for gains and losses, and depend on the utility function and underlying uncertainty. We provide analytic expressions and numerical examples for discount factors assuming simple utility functions and gaussian uncertainty.

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Publisher Info
Paper provided by EconWPA in its series Microeconomics with number 0506005.

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Length: 33 pages
Date of creation: 13 Jun 2005
Date of revision:
Handle: RePEc:wpa:wuwpmi:0506005

Note: Type of Document - pdf; pages: 33
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Web page: http://129.3.20.41

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Related research
Keywords: Time preference; discounted utility anomalies; decision-making under uncertainty; optimal stopping;

Find related papers by JEL classification:
D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
D91 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Consumer Choice; Life Cycle Models and Saving
C61 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Optimization Techniques; Programming Models; Dynamic Analysis
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Svetlana Boyarchenko & Sergey Levendorskiy, 2004. "Optimal stopping made easy," Finance 0410016, EconWPA. [Downloadable!]
    Other versions:
  2. Lowenstein, George & Prelec, Drazen, 1991. "Negative Time Preference," American Economic Review, American Economic Association, vol. 81(2), pages 347-52, May.
  3. Svetlana Boyarchenko & Sergei Levendorskii, 2004. "Practical guide to real options in discrete time," Finance 0405016, EconWPA. [Downloadable!]
    Other versions:
  4. Drew Fudenberg & David K. Levine, 2004. "A Dual Self Model of Impulse Control," Harvard Institute of Economic Research Working Papers 2049, Harvard - Institute of Economic Research. [Downloadable!]
    Other versions:
  5. Svetlana Boyarchenko & Sergei Levendorskii, 2004. "American options: the EPV pricing model," Finance 0405024, EconWPA. [Downloadable!]
    Other versions:
  6. 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.
  7. Robert C. Merton, 1973. "Theory of Rational Option Pricing," Bell Journal of Economics, The RAND Corporation, vol. 4(1), pages 141-183, Spring. [Downloadable!] (restricted)
  8. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March. [Downloadable!] (restricted)
  9. 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. [Downloadable!] (restricted)
  10. Svetlana Boyarchenko, 2004. "Irreversible Decisions and Record-Setting News Principles," American Economic Review, American Economic Association, vol. 94(3), pages 557-568, June. [Downloadable!]
  11. Tjalling C. Koopmans, 1959. "Stationary Ordinal Utility and Impatience," Cowles Foundation Discussion Papers 81, Cowles Foundation, Yale University. [Downloadable!]
  12. Efe A Ok & Yusufcan Masatlioglu, 2003. "A General Theory of Time Preferences," Levine's Bibliography 234936000000000089, UCLA Department of Economics. [Downloadable!]
  13. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June. [Downloadable!] (restricted)
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Gomes, Orlando, 2007. "Socially determined time preference in discrete time," MPRA Paper 3442, University Library of Munich, Germany. [Downloadable!]
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