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Checking the Evidence for Declining Discount Rates

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  • Szekeres, Szabolcs

Abstract

A numerical model is used to experimentally compute certainty equivalent discount rates (CERs) of risk neutral and risk-averse decision makers. Investors are characterized by utility functions of the constant-intertemporal-elasticity-of-substitution (CIES) type. Stochastic interest rates are generated using a Cox, Ingersoll & Ross (CIR) type model, calibrated to 1992-2017 US three-month Treasury Bill rates. The paper replicates empirical studies providing evidence for declining discount rates (DDRs) and tests claims regarding risk averse CERs in a descriptive discounting context. It is shown that DDRs as proposed by Weitzman are based on a fallacy. The reviewed papers seeking empirical evidence of DDRs repeat the mistake. Risk averse CERs can be decline with time because of portfolio effects. If these are low, risk averse CERs are slightly lower than risk neutral ones but not secularly declining.

Suggested Citation

  • Szekeres, Szabolcs, 2020. "Checking the Evidence for Declining Discount Rates," MPRA Paper 102233, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:102233
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    File URL: https://mpra.ub.uni-muenchen.de/102233/1/MPRA_paper_102233.pdf
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    References listed on IDEAS

    as
    1. Christian Gollier & Phoebe Koundouri & Theologos Pantelidis, 2008. "Declining discount rates: Economic justifications and implications for long-run policy [‘Regime switches in interest rates’]," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 23(56), pages 758-795.
    2. Freeman, Mark C. & Groom, Ben & Panopoulou, Ekaterini & Pantelidis, Theologos, 2015. "Declining discount rates and the Fisher Effect: Inflated past, discounted future?," Journal of Environmental Economics and Management, Elsevier, vol. 73(C), pages 32-49.
    3. Newell, Richard G. & Pizer, William A., 2003. "Discounting the distant future: how much do uncertain rates increase valuations?," Journal of Environmental Economics and Management, Elsevier, vol. 46(1), pages 52-71, July.
    4. Phoebe Koundouri & Theologos Pantelidis & Ben Groom & Ekaterini Panopoulou, 2007. "Discounting the distant future: How much does model selection affect the certainty equivalent rate?," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 22(3), pages 641-656.
    5. William Nordhaus, 2019. "Climate Change: The Ultimate Challenge for Economics," American Economic Review, American Economic Association, vol. 109(6), pages 1991-2014, June.
    6. Martin L. Weitzman, 2001. "Gamma Discounting," American Economic Review, American Economic Association, vol. 91(1), pages 260-271, March.
    7. Christian Gollier & James K. Hammitt, 2014. "The Long-Run Discount Rate Controversy," Annual Review of Resource Economics, Annual Reviews, vol. 6(1), pages 273-295, October.
    8. Weitzman, Martin L., 1998. "Why the Far-Distant Future Should Be Discounted at Its Lowest Possible Rate," Journal of Environmental Economics and Management, Elsevier, vol. 36(3), pages 201-208, November.
    9. Szekeres, Szabolcs, 2018. "Why expected discount factors yield incorrect expected present values," MPRA Paper 91187, University Library of Munich, Germany, revised 02 Jan 2019.
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    Cited by:

    1. Szekeres, Szabolcs, 2021. "Should CBA use descriptive or prescriptive discount rates? It should use both!," MPRA Paper 106029, University Library of Munich, Germany.
    2. Szekeres, Szabolcs, 2021. "Should CBA use descriptive or prescriptive discount rates? It should use both!," MPRA Paper 108397, University Library of Munich, Germany.

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    More about this item

    Keywords

    Weitzman-Gollier puzzle; declining discount rates; discounting;
    All these keywords.

    JEL classification:

    • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate

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