Intertemporal Choice - SS200 Behavioural Economics - 21 January 2004 by Martin Barner

Papers Frederick, Loewenstein & O’Donoghue: ”A review of intertemporal choice” (2002) Angeletos, Laibson, Repetto, Tobacman & Weinberg: ”The hyperbolic consumption model” (2001) Laibson: ”Golden eggs and hyperbolic discounting” (1997)

Agenda Motivation History of intertemporal choice Anomalies from discounted utility theory Two examples of hyperbolic discounting Results of simulations in Angeletos et al Conclusions and perspectives

Motivation What is analyzed Why care What to learn Citation

History of intertemporal choice Adam Smith (1776) John Rae (1834) Eugen von Böhm-Bawerk (1889) Irving Fisher (1930) Paul Samuelson (1937) Robert Strotz (1956) Phelps and Pollak (1968) David Laibson (1994, 1997)

Discounted Utility Model Discount rate expresses motives Accepted as normative and descriptive Utility and consumption independence Time consistency Opposing forces Diminishing marginal utility Positive time preference

Definitions Time discounting Reason for caring less about future Time preference Immediate utility over delayed utility

Anomalies from DU Empirically discount rates not constant Over time Across type of intertemporal choices Sign effect (gains vs. losses) Magnitude effect (small vs. large amounts) Sequence effect (sequence vs. singly)

Figure 1: - from Frederick et al ,

Figure 2: - from Frederick et al ,

Hyperbolic discounting Declining rate of time preference

Example 1: ”Golden eggs and hyperbolic discounting” Substancial benefit in long run… …But temptation in short run Illiquid assets provide commitment Two-thirds of American wealth illiquid Not counting human capital Access to credit reduce commitment Explain decline in savings rate 1980s

Figure 3: - from Laibson ,

Example 2: ”The hyperbolic consumption model” Long run intentions and short run actions Hyperbolic preferences induce dynamic inconsistency Sophisticated consumers Model with simulations

Example 2 (continued) Model features uncertain future labour income liquidity constraint allow to borrow on credit cards - limit hyperbolic discounting – implications labour income autocorrelated – shocks hold liquid and illiquid assets Results

Figure 4: - from Angeletos et al ,

Figure 5: - from Angeletos et al ,

Figure 6: - from Angeletos et al ,

Figure 7: - from Angeletos et al ,

Table 1: - from Angeletos et al ,

Table 2: - from Angeletos et al ,

Conclusion Use insight from psychology Relinguish finding the right discount rate Intertemporal choice reflects considerations Descriptively adequate models are not easy Not general theory – degrees of freedom

Behavioural perspectives Other models (instantaneous utility function) Habit formation Reference point models Visceral influence Projection bias Multiple self