Anomalies in intertemporal choice, time-dependent uncertainty and expected utility - A common approach

Various anomalies in intertemporal choice are explained within a common framework of time-dependent uncertainty and state-dependent expected utility: By considering temporary emotions in addition to the permanent wealth effects associated with the realization of delayed gains and losses, it can be shown that S-shaped probability weighting and hyperbolic discounting will be positively correlated traits, Constant relative risk aversion and time-dependent uncertainty are sufficient to generate a 'sign effect' (losses are discounted less than gains), a 'delay/speed-up' asymmetry (delays are discounted at higher/lower rates for gains/losses) and a 'magnitude effect' for losses (larger outcomes are discounted less). However, a 'reverse' magnitude effect develops for gains (larger outcomes are discounted more). The 'magnitude effect' for gains observed in experimental settings can be rationalized either by introducing various transaction costs or by postulating that, as expected gains/losses get larger, subjects 'think twice' and try to suppress the emotional bias consciously. As a corollary to the 'reverse' magnitude effect, a wealth effect is identified: being poorer, the same subject will be less patient with regard to gains and losses. The presence of pre-outcome emotions raises discount rates for short resolution lags.