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Present Bias and Discount Rate Risk

Author

Listed:
  • Lars A. Lochstoer
  • Stig R. H. Lundeby
  • Zhaneta K. Tancheva

Abstract

Recent evidence in the psychology literature suggests that individuals' degree of present bias varies with the state of nature and increases under stress. Consistent with this notion, we document, using survey data on individuals’ expected and realized consumption growth, that agents indeed tend to overconsume relative to their expectations and that the degree of such overconsumption is higher in bad times. We analyze the asset pricing implications of this bias and show that even if they control a small fraction of wealth, investors with time-varying degree of present bias cause substantial, priced discount rate risks that have first-order impact on the level and time-variation of asset risk premiums. The mechanism is distinct from that of models with time-varying preference parameters and that of models with biased expectations about aggregate outcomes.

Suggested Citation

  • Lars A. Lochstoer & Stig R. H. Lundeby & Zhaneta K. Tancheva, 2025. "Present Bias and Discount Rate Risk," NBER Working Papers 34453, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:34453
    Note: AP
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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