Intertemporal Choice Ec 101 Prof. Camerer Time preference: Preferences for earlier vs later rewards Important choices involve time longer time horizon more irreversibility careers, children, retirement Likely to be difficult the brain is not evolved for long- term reward self-control: addiction, obesity, procrastination
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Intertemporal Choice Ec 101 Prof. Camerer Time preference: Preferences for earlier vs later rewards Important choices involve time longer time horizon.
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Intertemporal ChoiceEc 101 Prof. Camerer
Time preference: Preferences for earlier vs later rewards
Important choices involve time longer time horizon more irreversibility
careers, children, retirement
Likely to be difficult the brain is not evolved for long-term reward self-control: addiction, obesity, procrastination
Institutions may help or hurt ”No money down!” vs expert advice & external self-control (Soc. Security)
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1 Some history of intertemporal choice 2 Anomalies from discounted utility theory (LFR
review) Field tests
3 Projection bias 4 Life-cycle savings
Mental accounting puzzles Calibration exercise (Angeletos et al) Experimental data
5 Research frontiers: Practical lessons Sophistication vs naivete
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1. Some history of intertemporal choice (see Loewenstein, ch 1 L-Elster Choice Over Time) Adam Smith (1776)
”impartial spectator” (cingulate, PFC?)
John Rae (1834) Eugen von Böhm-Bawerk (1889) Irving Fisher (1930) Paul Samuelson (1937) Robert Strotz (1956) Phelps and Pollak (1968)
Β- δ used to explain discounting of self and children (“future selves”)
David Laibson (1994,97) adapted PP 68
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E.g., Fisher– Personal determinants of time preference
• Foresight• Risk of future• Self-control• Habit• Life-expectancy• Concern for lives of other persons• Fashion: “In whatever direction the leaders of fashion first
chance to move, the crowd will follow in mad pursuit…”• Was critical of econ-psych divide:
– The fact that there are two schools, the productivity school and the psychological school, constantly crossing swords on this subject is a scandal in economic science and a reflection on the inadequate methods employed by these would-be destroyers of each other
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Discounted Utility Model
Discount factor compresses many Fisherian forces into one term
Now accepted as normative and descriptive ”It is completely arbitrary to
assume that the individual behaves so as to maximize an integral of the form evisaged in [DU]. (Samuelson 1937)
Utility and consumption independence Exponential time consistency
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2. Anomalies from DU (LFR)
Measured discount factors are not constant 1. Over time2. Across type of intertemporal choices
Sign effect (gains vs. losses) Neural substitution of ”loss” and
• Winter-item catalog sales (Conlin, O’Donoghue, Vogelsang AER in press)– 2.4 million observations 95-99. One 1 day to process, 3-7 days to ship– Theory predicts returns will depend + on temperature on return day R - on temperature on order day O
intuition: lower temp(O) ”surprised” at ”high” temp(R) and then return
temp(O)
temp (R)
Structural estimates of α from .01-.64
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4. Lifecycle savings ”Golden eggs and hyperbolic
discounting” Hyperbolics are tempted Illiquid assets provide commitment Two-thirds of US wealth illiquid (real
estate) Not counting human capital
Access to credit reduces commitment Explain decline in savings rate
1980s?
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Borrowing: Boom in bankruptcies
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Borrowing: Credit card facts
• Average debt outstanding by income quintile (IQ)
• Rates (APR, red) have
fallen as interest rates fall (blue). Blue is “spread”
$0
$500
$1,000
$1,500
$2,000
$2,500
$3,000
1970 1977 1983 1989 1992 1995 1998 2001
IQ 1
IQ 2
IQ 3
IQ 4
IQ 5
14.8%14.4% 14.5% 14.6% 14.4% 14.3% 14.3%
13.7%
12.8%12.3%
6.6% 6.4% 6.4%
5.3%5.7%
6.0%
5.0%4.6%
4.0% 4.3%
'95 '96 '97 '98 '99 '00 '01 '02 '03 '04
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Mental accounting and MPC (Thaler-Shefrin 1988)
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Angeletos et al calibration Model features
Quasi-hyperbolic sophisticated preferences uncertain future labor income liquidity constraint allow to borrow on credit cards - limit hyperbolic discounting – implications labor income autocorrelated – shocks hold liquid and illiquid assets
Calibration strategy:Fix some parameters, simulate behavior, compare properties with data
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Figure 3: Shapes of discount functions
,
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Figure 4: - from Angeletos et al
,
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Figure 5: - from Angeletos et al
,
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Figure 6: - from Angeletos et al
,
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Figure 7: - from Angeletos et al
,
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Table 1: - from Angeletos et al
,
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Table 2: - from Angeletos et al
,
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Habit formation Spending• “The hedonic treadmill”
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Habit formation Spending• “The hedonic treadmill”
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Optimal saving and investing: Do ‘sufficiently rational agents optimize?’
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Economics Nobel laureates reflect (from LA Times)
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Beverage delivery apparatus
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5. Research frontiers: Sophistication vs naivete
• Are hyperbolics “sophisticated”? or “naïve”? • Sophisticated hyperbolics will prefer pre-commitment
– IRS refunds– Deadlines (Blockbuster vs Netflix)– Ulysses and the sirens– “Arrest me” list on riverboat casinos– Wertenbroch:
• Smaller package sizes of “vices” than “virtues” • Cigarettes by the pack, gym contracts (Malmendier-Della Vigna
AER 06, $19/visit vs $10 visit fee)
• Q: Will markets work? Or does government have special legal power to enforce these contracts? (e.g. Army AWOL)
Problem: Measured δ system is all stimulus activity…use difficulty to separate δ (bottom left), δ more active in late
decisions with immediacy…but is it δ or complexity?
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Other aspects of time in econ Other models and phenomena Habit formation (common in macro) Visceral influence (emotion-cognition) Temptation preferences (Gul-Pesendorfer 01 Emetrica)
w{w,t}t iff U(S)=maxxS[u(x)+v(x)] –maxy S v(y) Anxiety/savoring/memory as consumption (Caplin-Leahy; e.g. wedding planning) Multiple selves/dual process models
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Types of anticipation preferences• Reference-dependent preferences (K-Rabin 04)
– Belief about choice changes reference point– Endowment effects/”auction fever”– Explains experience effects (experienced traders expect to
lose objects, doesn’t enter endowment/ f1)• Emotions and self-regulation
– E.g. depression. Focusses attention on bad outcomes, causes further depression
• Intimidating decisions– f1 may increase stress about future choices– health care, marriage, job market, etc. – Better to pretend future choice=status quo
• Q: When are these effects economically large?’– Avoid the doctor late cancer diagnosis– Supply side determination of endowment effects (marketing)
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Three interesting patterns• Self-fulfilling beliefs
– u2(δz,z)>u2(δz,z’) u2(δz’,z’)> u2(δz’,z)– prefer z if you expect(ed) z, z’ if you expect(ed) z’ – Cognitive dissonance, encoding bias
• “If I could change the way/I live my life today/I wouldn’t change/a single thing”– Lisa Stansfield
• Undermines learning from mistakes
• Time inconsistency– Self 2 prefers z’ given beliefs u2(f1,z’)>u2(f1,z)– but self 1 preferred to believe and pick z u1(x,δz,z)>u1(x,δz’,z’)– Problem: Beliefs occur after self 1 picks
• Informational preferences– Resolution-loving: Likes to know actual period 2 choice ahead of time– Information-neutral: Doesn’t care about knowing choice ahead of time
(“go with the flow”)– Information-loving: Prefers more information to less (convex utility in f1)– Disappointment-averse (prefers correct to incorrect guesses):
• u1(x,δz,z)+u1(x,δz’,z’)> u1(x,δz’,z)+u1(x,δ• Surprising fact: If none of above hold, then personal equilibrium iff u* max’s
E(u1(z1,z2) I.e. only way beliefs can matter is through these three
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Koszegi, “Utility from anticipation and personal equilibrium”
• Framework: Two selves, 1 and 2– Choices z1,z2 , belief about z2 is f1
– u1(z1,f1,z2)– anticipation function Φ(z1,d2)=f1 (d2 is period 2 decision
problem)– personal equilibrium:
• each self optimizes• Φ(z1,d2)=s2(z1,Φ(z1,d2),d2) anticipate s2(.) choice
– Beliefs are both a source of utility and constraint
• Timeline: – Choose from z1 X d2. – Choose f1 from Φ. – Choose z2