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Title: Explaining the anomalies of the exponential discounted utility model
Authors: al-Nowaihi, Ali
Dhami, Sanjit
First Published: Sep-2007
Publisher: Dept. of Economics, University of Leicester
Abstract: In a major contribution, Loewenstein and Prelec (1992) (LP) set the founda- tions for the behavioral approach to decision making over time. We show that the LP theory is incompatible with two very useful classes of value functions: the HARA class and the constant loss aversion class. Resultingly, the LP theory has been used infrequently in applications, which have largely used the ; form of hyperbolic pref- erences. We propose a more general but equally tractable class of utility functions, the simple increasing elasticity (SIE) class, which is compatible with constant loss aversion in a reformulated version of LP. Allowing for reference dependence and dif- ferent discount rates for gains and losses the SIE class is able to explain impatience, gain-loss asymmetry, magnitude e¤ect, and the delay-speedup asymmetry even un- der exponential discounting. If combined instead with the (reformulated) LP theory, the SIE class in addition can also explain the common di¤erence e¤ect.
Series/Report no.: Papers in Economics
Type: Report
Appears in Collections:Reports, Dept. of Economics

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