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A value function that explains the magnitude and sign effects

  • Ali al-Nowaihi

    ()

  • Sanjit Dhami

    ()

Two of the anomalies of the exponentially discounted utility model are the 'magnitude effect' (larger magnitudes are discounted less) and the 'sign effect' (a loss is discounted less than a gain of the same magnitude). The literature has followed Loewenstein and Prelec (1992) in attributing the magnitude effect to the increasing elasticity of the value function and the sign effect to a higher elasticity for losses as compared to gains. We provide a simple, tractable, functional form that has these two properties, which we call the simple increasing elasticity value function (SIE). These functional forms underpin the main explanation of the magnitude and sign effects and may aid applications and further theoretical development.

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File URL: http://www.le.ac.uk/economics/research/RePEc/lec/leecon/dp08-31.pdf
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Paper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number 08/31.

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Date of creation: Sep 2008
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Handle: RePEc:lec:leecon:08/31
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  1. Marc Scholten & Daniel Read, 2006. "Discounting by Intervals: A Generalized Model of Intertemporal Choice," Management Science, INFORMS, vol. 52(9), pages 1424-1436, September.
  2. Read, Daniel, 2001. " Is Time-Discounting Hyperbolic or Subadditive?," Journal of Risk and Uncertainty, Springer, vol. 23(1), pages 5-32, July.
  3. Tversky, Amos & Kahneman, Daniel, 1992. " Advances in Prospect Theory: Cumulative Representation of Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 5(4), pages 297-323, October.
  4. Paola Manzini & Marco Mariotti, 2002. "A vague theory of choice over time," Game Theory and Information 0203004, EconWPA, revised 21 Jun 2002.
  5. Halevy, Yoram, 2004. "Strotz meets Allais: Diminishing Impatience and the Certainty Effect," Microeconomics.ca working papers yoram_halevy-2004-16, Vancouver School of Economics, revised 25 Feb 2014.
  6. Thaler, Richard, 1981. "Some empirical evidence on dynamic inconsistency," Economics Letters, Elsevier, vol. 8(3), pages 201-207.
  7. Loewenstein, George & Prelec, Drazen, 1992. "Anomalies in Intertemporal Choice: Evidence and an Interpretation," The Quarterly Journal of Economics, MIT Press, vol. 107(2), pages 573-97, May.
  8. Ok, Efe A. & Masatlioglu, Yusufcan, 2007. "A theory of (relative) discounting," Journal of Economic Theory, Elsevier, vol. 137(1), pages 214-245, November.
  9. Laibson, David I., 1997. "Golden Eggs and Hyperbolic Discounting," Scholarly Articles 4481499, Harvard University Department of Economics.
  10. Shane Frederick & George Loewenstein & Ted O'Donoghue, 2002. "Time Discounting and Time Preference: A Critical Review," Journal of Economic Literature, American Economic Association, vol. 40(2), pages 351-401, June.
  11. Marc Scholten & Daniel Read, 2006. "Beyond discounting: the tradeoff model of intertemporal choice," LSE Research Online Documents on Economics 22710, London School of Economics and Political Science, LSE Library.
  12. repec:ubc:pmicro:halevy-04-10-29-10-08-43 is not listed on IDEAS
  13. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March.
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