Hyperbolic Discounting Is Rational: Valuing the Far Future with Uncertain Discount Rates
Abstract
Conventional economics supposes that agents value the present vs. the future using an exponential discounting function. In contrast, experiments with animals and humans suggest that agents are better described as hyperbolic discounters, whose discount function decays much more slowly at large times, as a power law. This is generally regarded as being time inconsistent or irrational. We show that when agents cannot be sure of their own future one-period discount rates, then hyperbolic discounting can become rational and exponential discounting irrational. This has important implications for environmental economics, as it implies a much larger weight for the far future.
Keywords: Hyperbolic discounting, Environment, Time consistent, Exponential discounting, Geometric random walk, Term structure of interest rates