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Hyperbolic Discounting Is Rational: Valuing the Far Future with Uncertain Discount Rates

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Abstract

Conventional economics supposes that agents value the present vs. the future using an exponential discounting function. In contrast, experiments with animals and humans suggest that agents are better described as hyperbolic discounters, whose discount function decays much more slowly at large times, as a power law. This is generally regarded as being time inconsistent or irrational. We show that when agents cannot be sure of their own future one-period discount rates, then hyperbolic discounting can become rational and exponential discounting irrational. This has important implications for environmental economics, as it implies a much larger weight for the far future.

Suggested Citation

  • J. Doyne Farmer & John Geanakoplos, 2009. "Hyperbolic Discounting Is Rational: Valuing the Far Future with Uncertain Discount Rates," Cowles Foundation Discussion Papers 1719, Cowles Foundation for Research in Economics, Yale University.
  • Handle: RePEc:cwl:cwldpp:1719
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Is hyperbolic discounting rational?
      by Economic Logician in Economic Logic on 2009-09-21 19:54:00
    2. The sickness of short-term-ism -- it's everywhere
      by Mark Buchanan in The Physics of Finance on 2011-07-06 17:36:00
    3. Deep Discounting Errors?
      by Mark Buchanan in The Physics of Finance on 2011-05-28 15:42:00

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    Cited by:

    1. David F. Burgess & Richard O. Zerbe, 2013. "Appropriate discounting for benefit–cost analysis," Chapters, in: Scott O. Farrow & Richard Zerbe, Jr. (ed.), Principles and Standards for Benefit–Cost Analysis, chapter 7, pages 247-263, Edward Elgar Publishing.
    2. Daniele Pennesi, 2017. "Uncertain discount and hyperbolic preferences," Theory and Decision, Springer, vol. 83(3), pages 315-336, October.
    3. Jaume Masoliver & Miquel Montero & Josep Perelló, 2021. "Jump-Diffusion Models for Valuing the Future: Discounting under Extreme Situations," Mathematics, MDPI, vol. 9(14), pages 1-26, July.
    4. Josep Perell'o & Miquel Montero & Jaume Masoliver & J. Doyne Farmer & John Geanakoplos, 2019. "Statistical analysis and stochastic interest rate modelling for valuing the future with implications in climate change mitigation," Papers 1910.01928, arXiv.org, revised Feb 2020.
    5. Herwig Buchholz & Thomas Eberle & Manfred Klevesath & Alexandra Jürgens & Douglas Beal & Alexander Baic & Joanna Radeke, 2020. "Forward Thinking for Sustainable Business Value: A New Method for Impact Valuation," Sustainability, MDPI, vol. 12(20), pages 1-16, October.
    6. Gaël Giraud & Céline Rochon, 2010. "Transition to Equilibrium in International Trades," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00657038, HAL.
    7. Mark Dean & Anja Sautmann, 2014. "Credit Constraints and the Measurement of Time Preferences," Working Papers 2014-1, Brown University, Department of Economics.
    8. Orlando Gomes & Alexandra Ferreira-Lopes & Tiago Sequeira, 2014. "Exponential discounting bias," Journal of Economics, Springer, vol. 113(1), pages 31-57, September.
    9. Karen Pittel & Dirk T.G. Rübbelke, 2012. "Decision processes of a suicide bomber—the economics and psychology of attacking and defecting," Defence and Peace Economics, Taylor & Francis Journals, vol. 23(3), pages 251-272, June.
    10. Eric Crampton & Matt Burgess & Brad Taylor, 2011. "The Cost of Cost Studies," Working Papers in Economics 11/29, University of Canterbury, Department of Economics and Finance.
    11. Matthew O. Jackson & Leeat Yariv, 2014. "Present Bias and Collective Dynamic Choice in the Lab," American Economic Review, American Economic Association, vol. 104(12), pages 4184-4204, December.
    12. Koen Vermeylen, 2013. "The Consumption Discount Rate for the Distant Future (if we do not die out)," Tinbergen Institute Discussion Papers 13-201/VI, Tinbergen Institute.
    13. J. Farmer & Cameron Hepburn & Penny Mealy & Alexander Teytelboym, 2015. "A Third Wave in the Economics of Climate Change," Environmental & Resource Economics, Springer;European Association of Environmental and Resource Economists, vol. 62(2), pages 329-357, October.
    14. Dorje C. Brody & Lane P. Hughston, 2013. "Social Discounting and the Long Rate of Interest," Papers 1306.5145, arXiv.org, revised Sep 2015.
    15. Katz, Yuri A., 2017. "Value of the distant future: Model-independent results," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 466(C), pages 269-276.
    16. J. Doyne Farmer & John Geanakoplos & Jaume Masoliver & Miquel Montero & Josep Perello, 2014. "Discounting the Distant Future," Cowles Foundation Discussion Papers 1951, Cowles Foundation for Research in Economics, Yale University.
    17. Dorje C. Brody & Lane P. Hughston, 2018. "Social Discounting And The Long Rate Of Interest," Mathematical Finance, Wiley Blackwell, vol. 28(1), pages 306-334, January.
    18. Koen Vermeylen, 2013. "Non-Marginal Cost-Benefit Analysis and the Tyranny of Discounting," Tinbergen Institute Discussion Papers 13-203/VI, Tinbergen Institute.
    19. Boyarchenko, Svetlana & Levendorskii, Sergei, 2010. "Discounting when income is stochastic and climate change policies," MPRA Paper 27998, University Library of Munich, Germany.

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    More about this item

    Keywords

    Hyperbolic discounting; Environment; Time consistent; Exponential discounting; Geometric random walk; Term structure of interest rates;
    All these keywords.

    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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