Uncertainty Under Hyperbolic Discounting: The Cost of Untying Your Hands

Produced by: 
Pontificia Universidad Javeriana
Available from: 
March 2019
Paper author(s): 
Christian Diego Alcocer
Julián Ortegón
Alejandro Roa
Financial Economics

The relevance of present consumption bias on personal finance has been confirmed in several studies. We propose a finite horizon model that is readily generalized to include risk and uncertainty on future income within a hyperbolic discounting framework. Our functional assumptions allow us to find a closed solution so we can provide a detailed analysis of behavior under varying risk scenarios and availability of commitment devices. We develop a measure of the cost of intertemporal inconsistencies by analyzing how an agent’s utility is greater when they tie their hands than when they are free to re-evaluate and change their consumption schedule. Much like a patient going through cognitive behavioral therapy (CBT) to quit smoking who is advised throw away his cigarette packs to avoid temptation. This lack-of-self-control cost only depends on the measure of the present bias and on the discount factor. We conclude by discussing consistent estimation methods of these biases and the effects of our results on agent-based simulations, industrial organization, experimental economics, labor markets and public sector mechanism design.


Research section: 
Latest Research
Share this