Time and risk preferences Flashcards
what are discount rates
used to put present value on costs/benefits that happen in the future
what to standard economic rationals do
- use exponential discount rate = discount rate is constant
- compares present and future utilities and chooses the one that maximises net discounted utility
- discounting between 2 equally spaced points in time is the same, now or in the future
- size and sign doesnt matter = paying a fine later is same as receiving money later
what is intertemporal choices
decisions with consequences that play out over time - decisions made that affect future opportunities
what do discount rates depend on
- your time preference
- how impatient you are = smaller discount fate - would rather have benefit today - the higher 1000 + x has to be for me - I need a bigger compensation of money
- high discount factor - I dont discount the future that much - I am patient - dont need compensation
how is exponential discounting consistent with time
discount factor is the same =
graph - y= utility, x= time –> doesnt matter what time period it occurs - the functions wont cross
results from Thaler 1981
- receiving money
= discounting
how much do you have to be compensated for waiting … to get 15£ today
- discount rate is higher for lower money
- discount rate drops sharply when time increases
- high compensation is needed for a small amount in the near future
- become more patient when it occurs later
results from Thaler 1981
- losses
= discounting
how much would you be willing to pay for an extended deadline on having to pay back a fine of 15£ if you had the option to pay back in
- result - they would only pay a little more for the extra time they are given
discount rates for real people
- hyperbolic discounting = decline in time
- magnitude effect = decreases in the size of the cash flow - more money needs less compensation
- sign effect = smaller for losses than for gains
- people are present biased = discount the near future more that the distant future
evidence that hyporbolic disocunting happens to everyone
study on humans rats and pigeons shows that they all experience hyperbolic discount rates that are not constant
- pigeons are very impatient = process instant rewards and later rewards differently
what is quasi hyperbolic discounting
more in line with data we observe
- exhibits present bias
- heavily discount closer events that further = special value we put on immediate rewards
- we would rather benefit now and cost later than cost now and benefit later
example of present bias
For example, a present-biased person might prefer to receive ten dollars today over receiving fifteen dollars tomorrow, but wouldn’t mind waiting an extra day if the choice were for the same amounts one year from today versus one year and one day from today
how does it affect willpower
- leads to dynamic inconsistency = indifference curves that cross over = shouldn’t happen = wouldnt happen with exponential discounting
- would rather benefit in the short term than get a even bigger benefit in the future because of discounting
how is procrastination explained by discounting
occurs when present costs are more salient than future costs, even though future costs can build up to be a lot bigger - discounting the future makes it seem less worse = wont do it today - because they can do it tomorrow when the cost isnt as big
- explains why people dont sign up to pension schemes because of present costs being big, even though in the LR without pension = bad - future costs dont seem as bad to me
why are people present biased and how it links to procrastination
people need immediate satisfaction, they are present bias - are bias towards their present selves so put greater weight on choice that will currently benefit them
- procrastinate because currently better for them - even though in the future it will be worse
Thaler explaining time inconsistency = multiple selves
planner = plans to quit smoking
doer = when that time period arrives succumbs again
- present bias - benefits more by not doing
- if he was a expdisc = would be same self throughout
- hyperbolic discounter = their preferences change according to B and discount factor = selfs want different things
- does discounts the near future heavily
how do commitment strategies help deal with temptation?
- self deployed strategies = make changes so your long term choices are more appealing = alarm clock on other side of room, routine, doing tasks immediately - not succumbing to present bias
- other deployed strategies = enforce policies that reduces failure of self control = defaults, change the way individuals think = social labeling - it is pyschologically costing to deviate from plans
commitment strategies reference
Duckworth 2018
loss aversion
losses loom larger than gains of the equivalent size
- over emphasise costs and downplay benefits
what are risk preferences
The attitude people hold towards risk - have implications for decsion making
how is risk modelled in standard economic theory
modelled as lotteries with known probabilities and clear outcomes
but in real outcomes probabilities and outcomes are unclear
- we can tell peoples general risk attitude by lab experiments and field
what are the types of risk preferences
risk neutral
risk seeking
risk averse = dont like risk
how do you measure peoples risk preferences
finding the certaintity equivalent
- how much certain money would make them indifferent between playing the gamble and receiving that money
- survey - list method - at each level of certain money increasing by 10 pounds - would you rather have the self payment or play a lottery with 50% of winning 300
- CE = when there transition over - would no longer participate in lottery if i was given £60 - CE = 55
the lower the certainty equivalence ..
the more risk averse
- dont want to gamble - happy with small certain amount of money
what is risk premium
difference between EV and CE = how much they are willing to forgo to get certain amount
