An analysis of intertemporal inconsistency through the hyperbolic factor

Abstract

Intertemporal choices play a fundamental role in the lives of individuals, and the Discounted Utility model is the essential framework for describing decision makers’ attitudes in front of alternatives structured over multiple periods. The classical formulation of the model assumes constant preferences over time, i.e., it assumes that individuals’ choices are consistent. Empirical evidence, however, shows that individuals’ preferences do not respond to this assumption, generating temporally inconsistent decisions. This paper addresses the problem of temporal inconsistency in order to interpret and describe anomalous choices, i.e., not rationalizable from a theoretical point of view, through the cognitive distortions of the decision-maker. Indeed, even if we assume that the investor is a rational subject, behavioral finance suggests that an anomaly is part of the human being and must be recognized as a systematic condition of the decision-making process. Exploiting the relationship between the rate of impatience and temporal preference, this work aims to demonstrate that the degree of decrease in impatience quantifies the weight of emotional drives in the anomalies of intertemporal choices. An experimental approach based on constructing the hyperbolic factor for each individual in different contexts is presented to test our results. The variability in the collected data highlights that individuals’ behavior is very different, suggesting the need to project strategies in personalized finance.