Time preferences, rates of return, and real-world investment decisions

Time preferences are central to all welfare analyses involving intertemporal tradeoffs. We use a model with endogenous interest rates to study the relationship between underlying time preferences and the interest rates people pay. The model suggests that bad shocks push people to pay higher rates than normal, so a single measurement of a preference for “money earlier or later” (MEL) provides little information on underlying preferences. We use several surveys associated with a panel of respondents’ credit bureau records to compare MEL responses to actual borrowing and saving behavior. While people who are paying higher interest rates do tend to prefer money earlier, the relationship is weak; we strongly reject the hypothesis that survey participants directly respond to MEL questions through comparison to their real-world rates of return on investments. As predicted by the model, negative shocks induce people to borrow more, want money earlier, and pay higher interest rates. Borrowing behavior appears to quickly mean revert, however. We propose an alternative approach to measuring time preferences that uses repeated observations of interest rates in large financial data sets.