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A theory of endogenous time preference, and discounted utility anomalies

  • Svetlana Boyarchenko

    (The University of Texas at Austin)

  • Sergei Levendorskii

    (The University of Texas at Austin)

We explain essentially all known discounted utility anomalies as artefacts of the optimizing behavior of an individual with a time- separable utility function, who perceives a good as a source of a stochastic consumption stream, and believes that she can wait for an optimal moment to buy or sell the good. For this individual, the fair price of the corresponding utility stream is interpreted as an integral of a deterministic utility stream multiplied by certain non-exponential factors which we interpret as endogenous discount factors; the factors are different for gains and losses, and depend on the utility function and underlying uncertainty. We provide analytic expressions and numerical examples for discount factors assuming simple utility functions and gaussian uncertainty.

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File URL: http://econwpa.repec.org/eps/mic/papers/0506/0506005.pdf
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Paper provided by EconWPA in its series Microeconomics with number 0506005.

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Length: 33 pages
Date of creation: 13 Jun 2005
Date of revision:
Handle: RePEc:wpa:wuwpmi:0506005
Note: Type of Document - pdf; pages: 33
Contact details of provider: Web page: http://econwpa.repec.org

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  1. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  2. 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.
  3. Sergey Levendorskiy & Svetlana Boyarchenko, 2004. "Practical guide to real options in discrete time," Computing in Economics and Finance 2004 137, Society for Computational Economics.
  4. Fudenberg, Drew & Levine, David, 2006. "A Dual-Self Model of Impulse Control," Scholarly Articles 3196335, Harvard University Department of Economics.
  5. Svetlana Boyarchenko & Sergey Levendorskiy, 2004. "Optimal stopping made easy," Finance 0410016, EconWPA.
  6. Svetlana Boyarchenko & Sergei Levendorskii, 2004. "American options: the EPV pricing model," Finance 0405024, EconWPA.
  7. Efe A Ok & Yusufcan Masatlioglu, 2003. "A General Theory of Time Preferences," Levine's Bibliography 234936000000000089, UCLA Department of Economics.
  8. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-91, March.
  9. Harrison, J. Michael & Pliska, Stanley R., 1981. "Martingales and stochastic integrals in the theory of continuous trading," Stochastic Processes and their Applications, Elsevier, vol. 11(3), pages 215-260, August.
  10. 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.
  11. 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.
  12. Tjalling C. Koopmans, 1959. "Stationary Ordinal Utility and Impatience," Cowles Foundation Discussion Papers 81, Cowles Foundation for Research in Economics, Yale University.
  13. Lowenstein, George & Prelec, Drazen, 1991. "Negative Time Preference," American Economic Review, American Economic Association, vol. 81(2), pages 347-52, May.
  14. Svetlana Boyarchenko, 2004. "Irreversible Decisions and Record-Setting News Principles," American Economic Review, American Economic Association, vol. 94(3), pages 557-568, June.
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