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BH-6: Time Consistency and Dynamic Decisions
Weighted Discounting - On Group Diversity, Time-Inconsistency, and Consequences for Investment
1Tilburg University; 2University of Oxford; 3Columbia University
This paper studies the investment decisions of groups whose members disagree about the method of discounting. In particular, we provide a comprehensive treatment of discount functions that are given by the weighted average of the group members' discount functions. This class of "weighted discount functions" admits a natural notion of group diversity, which has consequences for investment behavior. We show that groups with greater group diversity discount any future payment less, and thus make more patient decisions. Within a real options framework, greater group diversity leads to delayed investment. Finally, we show that well-known behavioral discount functions can be written as a weighted discount function. Therefore, all results in this paper find a correspondence in a single agent setting with non-standard, behavioral time preferences. Our paper thus also solves the long-standing problem of optimal investment under hyperbolic discounting.
Probability Weighting, Stop-Loss and the Disposition Effect
1University of Warwick; 2University of Oxford; 3University of Cambridge
Prospect theory (PT) has long been linked with the disposition effect, the tendency of investors to sell assets that have risen in value but not those which have fallen. However the disposition effect predicted by dynamic PT models is too strong relative to empirical findings. The literature to date has concentrated on the implications of an S-shaped utility function.
We incorporate probability weighting into a continuous-time model of an asset sale, and solve for the optimal strategy. We find that individual investors follow a strategy which is stop-loss, but not stop gain; the optimal target distribution is skewed and has a long right-tail; the optimal strategy is not a pure threshold strategy. Moreover, for realistic parameterizations of standard models the predicted magnitude of the disposition effect matches that found by Odean (1998). If we aggregate over heterogeneous investors we can match approximately the selling rate data of Ben-David and Hirshleifer (2012).
Impulsive Consumption and Financial Wellbeing: Evidence from an Increase in the Availability of Alcohol
1Swedish House of Finance; 2The Ohio State University, NBER
Increasing the availability of temptation goods might harm individuals if they have time-inconsistent preferences and consume more of these goods in the present at the expense of their future consumption plan. We test whether consumers exploit a commitment mechanism to stick to their plan by studying the credit behavior of low-income Swedish households around the expansion of the opening hours of retail liquor stores during a nationwide experiment in Sweden. Consistent with the idea that consumers used the limited opening hours as a commitment device, expanded operating hours led not only to an increase in alcohol consumption (Nordström and Skog 2003) but also to an increase in consumer credit uptake and default. Thus, our results show that restricting the availability of temptation goods can increase the financial wellbeing of individuals with inconsistent-time preferences
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Conference: EFA 2017
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