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Microfoundations of Discounting

Author

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  • Alexander T. I. Adamou
  • Yonatan Berman
  • Diomides P. Mavroyiannis
  • Ole B. Peters

Abstract

An important question in economics is how people choose between different payments in the future. The classical normative model predicts that a decision maker discounts a later payment relative to an earlier one by an exponential function of the time between them. Descriptive models use non-exponential functions to fit observed behavioral phenomena, such as preference reversal. Here we propose a model of discounting, consistent with standard axioms of choice, in which decision makers maximize the growth rate of their wealth. Four specifications of the model produce four forms of discounting -- no discounting, exponential, hyperbolic, and a hybrid of exponential and hyperbolic -- two of which predict preference reversal. Our model requires no assumption of behavioral bias or payment risk.

Suggested Citation

  • Alexander T. I. Adamou & Yonatan Berman & Diomides P. Mavroyiannis & Ole B. Peters, 2019. "Microfoundations of Discounting," Papers 1910.02137, arXiv.org, revised Jan 2020.
    • Handle: RePEc:arx:papers:1910.02137
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    References listed on IDEAS

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    1. Ole Peters & Murray Gell-Mann, 2014. "Evaluating gambles using dynamics," Papers 1405.0585, arXiv.org, revised Jun 2015.
    2. George Loewenstein & Drazen Prelec, 1992. "Anomalies in Intertemporal Choice: Evidence and an Interpretation," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 107(2), pages 573-597.
    3. Ole Peters & Alexander Adamou, 2018. "The time interpretation of expected utility theory," Papers 1801.03680, arXiv.org, revised Feb 2021.
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    Cited by:

    1. Yonatan Berman & Mark Kirstein, 2021. "Risk Preferences in Time Lotteries," Papers 2108.08366, arXiv.org.

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