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Subjective Discounting in an Exchange Economy

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  • Erzo G. J. Luttmer
  • Thomas Mariotti

Abstract

This paper describes the equilibrium of a discrete-time exchange economy in which consumers with arbitrary subjective discount factors and homothetic period utility functions follow linear Markov consumption and portfolio strategies. Explicit expressions are given for state prices and consumption-wealth ratios. We provide an analytically convenient continuous-time approximation and show how subjective rates of time preference affect risk-free rates but not instantaneous risk-return trade-offs. Hyperbolic discount factors can be a source of return volatility, but they cannot be used to address asset pricing puzzles related to high-frequency Sharpe ratios.

Suggested Citation

  • Erzo G. J. Luttmer & Thomas Mariotti, 2003. "Subjective Discounting in an Exchange Economy," Journal of Political Economy, University of Chicago Press, vol. 111(5), pages 959-989, October.
  • Handle: RePEc:ucp:jpolec:v:111:y:2003:i:5:p:959-989
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    References listed on IDEAS

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    1. Juan D. Carrillo & Thomas Mariotti, 2000. "Strategic Ignorance as a Self-Disciplining Device," Review of Economic Studies, Oxford University Press, vol. 67(3), pages 529-544.
    2. Matthew Rabin & Ted O'Donoghue, 1999. "Doing It Now or Later," American Economic Review, American Economic Association, vol. 89(1), pages 103-124, March.
    3. Bezalel Peleg & Menahem E. Yaari, 1973. "On the Existence of a Consistent Course of Action when Tastes are Changing," Review of Economic Studies, Oxford University Press, vol. 40(3), pages 391-401.
    4. Harris, Christopher & Laibson, David, 2001. "Dynamic Choices of Hyperbolic Consumers," Econometrica, Econometric Society, vol. 69(4), pages 935-957, July.
    5. George Loewenstein & Drazen Prelec, 1992. "Anomalies in Intertemporal Choice: Evidence and an Interpretation," The Quarterly Journal of Economics, Oxford University Press, vol. 107(2), pages 573-597.
    6. E. S. Phelps & R. A. Pollak, 1968. "On Second-Best National Saving and Game-Equilibrium Growth," Review of Economic Studies, Oxford University Press, vol. 35(2), pages 185-199.
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