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Discount factors ex post and ex ante, and discounted utility anomalies

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Author Info

  • Svetlana Boyarchenko

    (The University of Texas, Austin)

  • Sergei Levendorskii

    (The University of Texas, Austin)

Abstract

The real options approach is used to explain discounted utility anomalies as artifacts of the optimizing behavior of an individual with standard preferences, who perceives the utility from consumption in the future as uncertain. For this ndividual, waiting is valuable because uncertainty is revealed over time. The fair price (or compensation) that the individual agrees to pay (or accept) today is the expected value of utility of the future gain (or loss) multiplied by a certain non- exponential factor which weinterpret as a discount factor ex ante. The factors ex ante are different for gains and losses, and depend on the utility function and underlying uncertainty. After the decision of exchange had been made, valuation ex post reduces to calculation of the standard expected present value. We provide analytic expressions and numerical examples for discount factors assuming different utility functions and models of uncertainty, and demonstrate that our explanation of discounted utility anomalies is robust.

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Bibliographic Info

Paper provided by EconWPA in its series Microeconomics with number 0510013.

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Length: 36 pages
Date of creation: 27 Oct 2005
Date of revision: 17 Nov 2005
Handle: RePEc:wpa:wuwpmi:0510013

Note: Type of Document - pdf; pages: 36
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Web page: http://128.118.178.162

Related research

Keywords: real options; time preference; discounted utility anomalies;

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References

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Cited by:
  1. Stefania Albanesi & Claudia Olivetti, 2007. "Gender Roles and Technological Progress," NBER Working Papers 13179, National Bureau of Economic Research, Inc.
  2. Jawwad Noor, 2007. "Hyperbolic Discounting and the Standard," Levine's Bibliography 321307000000000939, UCLA Department of Economics.
  3. Luis Alvarez & Teppo Rakkolainen, 2010. "Investment timing in presence of downside risk: a certainty equivalent characterization," Annals of Finance, Springer, vol. 6(3), pages 317-333, July.

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