Microfoundations of Discounting
Abstract
An important question in economics is how people choose between different payments in the future. The classical normative model predicts that a decision maker discounts a later payment relative to an earlier one by an exponential function of the time between them. Descriptive models use non-exponential functions to fit observed behavioral phenomena, such as preference reversal. Here we propose a model of discounting, consistent with standard axioms of choice, in which decision makers maximize the growth rate of their wealth. Four specifications of the model produce four forms of discounting -- no discounting, exponential, hyperbolic, and a hybrid of exponential and hyperbolic -- two of which predict preference reversal. Our model requires no assumption of behavioral bias or payment risk.
Cite
@article{arxiv.1910.02137,
title = {Microfoundations of Discounting},
author = {Alexander T. I. Adamou and Yonatan Berman and Diomides P. Mavroyiannis and Ole B. Peters},
journal= {arXiv preprint arXiv:1910.02137},
year = {2020}
}