The endowment effect and intertemporal choice: a laboratory investigation

We present a laboratory investigation of intertemporal choice (i.e., elicited discount rates) allowing for the influence of the endowment effect. Consistent with the previous literature, we hypothesize that the endowment effect in an intertemporal choice setting results in substantially higher discount rates relative to when individuals treat the resources in question as found money. Our results support this hypothesis and our experimental design provides a new protocol for conducting choice experiments wherein the endowment effect is an important determinant of behaviour.     

Rationality and intertemporal choice

The alleged problems associated with self-control, hyperbolic discounting and other examples of seemingly irrational intertemporal choice are examined in the context of an evolution-based neurobiological model that emphasizes the role of the biological evolution of big brains and language and the cultural evolution of institutions. There is no utility function in the brain; it has no central-planner, in fact, the brain is a self-organized complex system, a decentralized spontaneous order. This spontaneous order is coordinated, much like an economy, by a distributed network that maintains and makes available the discounted net value of various options to decentralized and specialized areas in the brain when making decisions. Further, that decision making is embodied and embedded in the decision making environment. For humans, an important part of that environment is the social environment consisting of institutions and other components of culture. It was, in part, the evolution of this environment that made long-range planning possible. Additionally, it is very often the lack of embedded experience with the environment that leads to what seems to be irrational intertemporal choices. In fact, under close examination the evidence for consistent irrational intertemporal choice is weak.     

Subjective random discounting and intertemporal choice

This paper provides an axiomatic foundation for a particular type of preference shock model called the random discounting representation where a decision maker believes that her discount factors change randomly over time. For this purpose, we formulate an infinite horizon extension of [E. Dekel, B. Lipman, A. Rustichini, Representing preferences with a unique subjective state space, Econometrica 69 (2001) 891-934], and identify the behavior that reduces all subjective uncertainties to those about future discount factors. We also show uniqueness of subjective belief about discount factors. Moreover, a behavioral comparison about preference for flexibility characterizes the condition that one's subjective belief second-order stochastically dominates the other. Finally, the resulting model is applied to a consumption-savings problem.     

Irrationality and intertemporal choice in early neoclassical thought

Early neoclassical economists presumed an element of irrationality in the context of intertemporal decision making. W.S. Jevons, Irving Fisher, Alfred Marshall, and A.C. Pigou observed a preference for present over future consumption, and each took this as evidence that consumer 'foresight' or 'will power' was defective. The labouring classes were said to discount future consumption to reflect uncertainty, and such discounting is regarded as 'rational.' But each of these economists focused on an additional, and purportedly 'irrational,' reason for discounting: 'impatience.' Consumers are thus said to make persistent miscalculations when it comes to decisions involving time.
Irrationalité et choix intertemporel dans les débuts de la pensée néo-classique. Les premiers économistes néo-classiques présumaient qu'il y avait un brin d'irrationalité dans le processus de décision intertemporel. W.S. Jevons, Irving Fisher, Alfred Marshall et A.C. Pigou ont observé une certaine préférence de la consommation présente par rapport à la consommation future et en ont déduit que le consommateur manquait de 'prévoyance' et de 'volonté.' On suggérait que les classes travailleuses escomptaient leur consommation future à cause de l'incertitude - ce qui était considé comme rationnel. Mais chacun de ces économistes faisait aussi appel à une raison additionnelle pour escompter la consommation future - l'impatience - un motif jugé irrationnel. On en concluait que les consommateurs faisaient des erreurs persistantes de calcul quand ils prenaient des décisions intertemporelles.     

The effect of sequential entry on choice of location

An important aspect of economics arises when entry into a market of differentiated products is sequential and essentially irrevocable. An approach to the investigation of this problem is offered by the theory of spatial competition. We consider a market consisting of a line segment or its equivalent and assume irrevocable location choices for all sellers, each of whom pursues a ‘maximin’ strategy in selecting a location, and negative elasticity of demand for all buyers. Results for small N are generalised to any finite N and the patterns are evaluated on a criterion of ‘Buyers' Welfare’.     

The effect of ambiguity aversion on reward scheme choice

We test the implications of ambiguity aversion in a principal–agent problem with multiple agents. Models of ambiguity aversion suggest that, under ambiguity, comparative compensation schemes may become more attractive than independent wage contracts. We test this by presenting agents with a choice between comparative reward schemes and independent contracts, which are designed such that under uncertainty about output distributions (that is, under ambiguity), ambiguity averse agents should typically prefer comparative reward schemes, independent of their degree of risk aversion. We indeed find that the share of agents who choose the comparative scheme is higher under ambiguity.     

The intertemporal substitution effect of government purchases on the interest rate: Empirical estimates for the Netherlands

In an intertemporal equilibrium setting, temporary government purchases may affect the real interest rate. A temporary change in the level of government spending does not affect the optimal intertemporal allocation of rational consumers, who will therefore try to maintain their consumption plans. Assuming no change in the supply of goods, there is an excess demand for goods and in a closed economy the real interest rate has to rise to maintain equilibrium at the goods market. In this paper it is examined whether predictions of intertemporal substitution models hold up to the experience of the Netherlands. We extend Barro's empirical work in three ways. First, we construct a new measure of temporary government outlays. Second, we take the time series behaviour of the data concerned into account and employ a less restrictive specification for the equation to be estimated. Third, we examine the intertemporal substitution effect of government purchases onreal interest rates. Our results provide only mixed support for the hypothesis that temporary government purchases raise real interest rates. It turns out that only temporary military outlays affect the nominal and real interest rate.     

Lab and framed lab versus natural experiments: Evidence from a risky choice experiment

Some recent papers have studied data from TV game shows to examine the behaviour of individuals towards risk. It is generally agreed that data from these shows are useful in detecting individual risk aversion in the field, with both “real life” subjects and incentives. Field experiments also include some interesting reality features that could affect individuals’ behaviour and possibly lead to different findings. This paper aims at investigating lab versus field evidence in risk taking attitudes, especially controlling for framing effects. To assess whether the behaviour of subjects in the field is consistent with that of experimental subjects, we designed an experiment to mimic (with experimental rewards and subjects) the rules of a well-known Italian TV game show, Affari Tuoi, in two different settings: a traditional lab setting, where the game was played individually (109 subjects) (Treatment 1); and a framed lab, in which the experiment was replicated in the Italian public television (RAI) studio where the show was actually recorded, with a smaller sample of undergraduate students (33) and in the presence of an audience (Treatment 2). Our comparison between the two different settings aims at establishing whether the presence of an audience, or of a situation that reproduces the stress that contestants must experience in the TV studio, can affect experimental subjects’ choices. We did not find any significant evidence of framing effects: students behave in a similar way in the two lab settings, responding essentially to incentives. Comparing the risk attitudes shown by experimental subjects in the two lab treatments with those exhibited by the contestants in the field, we found that contestants in the TV show are generally more risk averse than students in the lab.     

The effect of unemployment insurance on the riskiness of occupational choice

This paper examines the effect of unemployment insurance on the riskiness of occupational choice by postulating a model of job search in which job offers have two characteristics; their wage and their security of tenure. Two versions are considered: a general case in which the unemployment benefit is earnings-related, and a special case in which the benefit is of a flat-rate form. Of particular interest in the paper is the individual's desired trade-off between wage and security of tenure, and how this trade-off is affected by the type of insurance scheme in operation. Perhaps surprisingly, we find that an earnings-related scheme encourages risk-taking behaviour by the poor, and risk-avoiding behaviour by the rich; in contrast, a flat-rate scheme neither encourages nor discourages risk-taking.     

The Slutsky matrix and homogeneity in intertemporal consumer theory

A dual vista of an intertemporal model of the consumer yields insights into its fundamental qualitative structure that previous research was heretofore unable to uncover. For example, the intertemporal Slutsky matrix and its properties of symmetry and negative semidefiniteness apply to the integral of the discounted open-loop demand and supply functions, not to the instantaneous open-loop demand and supply functions. The results are established in a general dynamic model of the consumer which accounts for durable and nondurable goods, installation costs for the durable goods, and a leisure/labor choice.     

On the potential for observational equivalence in experiments on risky choice when a power value function is assumed

We demonstrate theoretically and illustrate the implications of assuming power utility when the true function is of the expo-power form. Empirical results can appear to be consistent with cumulative prospect theory when they are in fact generated from a Markowitz model.     

The intertemporal allocation of consumption,time preference,and life-history strategies

This paper studies the intertemporal allocation of consumption and time preference in both biological and economic framework. By incorporating intergenerational transfers to examine human life-history strategies, this study demonstrates that time discounting and mortality mirror the age-variation in the value of survival, which in turn depends on future reproduction and productive surplus. Consistent with empirical findings, the results suggest that our biologically endowed rate of time preference is positive, and is lowest in early adulthood, but increases thereafter. The results also offers a biological explanation for intertemporal loss aversion, indicating that time preference is higher when exchange transactions involve a reduction in current consumption than when they involve an increase in current consumption. In a broader perspective, this paper looks into the biological foundation of preferences and motivation. Establishing the foundation of preferences with biological models and incorporating the results into economic models enrich the understanding of our decision-making mechanism and behavior.     

Optimal choice of prevention and cure under uncertainty on disease effect and cure effectiveness

This paper studies optimal prevention and cure when an agent copes with two different sources of uncertainty: uncertainty on disease effect and uncertainty on cure effectiveness. We first analyze how optimal choices are affected by uncertainty when prevention and cure do not interact. Under both types of uncertainty, we obtain that the optimal level of prevention rises. Furthermore, we characterize for each source of uncertainty the conditions for the optimal level of cure to increase. We show that these conditions are related to different measures of prudence in health and cross-prudence in wealth. Lastly, we generalize our results to the case where prevention and cure interact and characterize for each source of uncertainty the conditions for the optimal level of prevention and cure to jointly increase. These conditions are similar to those obtained in the case without uncertainty but, in this context, Edgeworth–Pareto complementarity is also required.     

Consequences of irreversibilities on optimal intertemporal CO2 emission policies under uncertainty

This paper investigates how irreversibilities affect the optimal intertemporal accumulation of greenhouse gases in the atmosphere under uncertainty. More precisely, the evolution of the future temperature is assumed to follow an Itô-process with the drift provided by greenhouse gas emissions. This paper considers two different kinds of irreversibilities: of emissions (i.e., CO₂ once dissolved into the air cannot be collected later) and of stopping. These issues are investigated first (in the tradition of the real option literature) as pure stopping problems and then allowing for a continuous choice of emissions. Implications for global warming are: an irreversible stopping of greenhouse gas emissions is never optimal in a continuous framework and yields in the real option framework a less conservationist stopping rule in which uncertainty increases the stopping threshold (i.e. works against conservation).     

Combining stated and revealed choice research to simulate the neighbor effect: The case of hybrid-electric vehicles

According to intuition and theories of diffusion, consumer preferences develop along with technological change. However, most economic models designed for policy simulation unrealistically assume static preferences. To improve the behavioral realism of an energy–economy policy model, this study investigates the “neighbor effect,” where a new technology becomes more desirable as its adoption becomes more widespread in the market. We measure this effect as a change in aggregated willingness to pay under different levels of technology penetration. Focusing on hybrid-electric vehicles (HEVs), an online survey experiment collected stated preference (SP) data from 535 Canadian and 408 Californian vehicle owners under different hypothetical market conditions.Revealed preference (RP) data was collected from the same respondents by eliciting the year, make and model of recent vehicle purchases from regions with different degrees of HEV popularity: Canada with 0.17% new market share, and California with 3.0% new market share. We compare choice models estimated from RP data only with three joint SP–RP estimation techniques, each assigning a different weight to the influence of SP and RP data in coefficient estimates. Statistically, models allowing more RP influence outperform SP influenced models. However, results suggest that because the RP data in this study is afflicted by multicollinearity, techniques that allow more SP influence in the beta estimates while maintaining RP data for calibrating vehicle class constraints produce more realistic estimates of willingness to pay. Furthermore, SP influenced coefficient estimates also translate to more realistic behavioral parameters for CIMS, allowing more sensitivity to policy simulations.     

The intertemporal relation between government revenue and expenditure in the United Kingdom, 1750 to 2004

We examine the intertemporal relation between government revenue and expenditure in the UK during 1750 to 2004. We pay particular attention to long run trends by applying a battery of unit root and cointegration techniques to the data, and we use a modified Granger causality test on data spans organized around structural breaks in the series. The results suggest that, allowing for structural breaks, UK real revenue and spending are I(1) series and cointegrated and that Granger causality runs from government spending to revenue. As such, the ‘spend-tax’ hypothesis appears to best characterize the long run intertemporal relation between government revenue and spending in the UK.