Behavioral Finance (BeFi) – Hyperbolic Discounting

Behavioral Finance (BeFi) – Hyperbolic Discounting


Hyperbolic Discounting is a much-talked-about cognitive bias in behavioral finance. What is hyperbolic discounting? What it really
means is that people typically intend to forefeit small, immediate gains for larger rewards in the future,
but when they have to make the decision they often fail to make optimal decision at that time. The decision
maker values the small, immediate reward more than the larger future reward. That
is, would you prefer $1 today or $3 tomorrow or
$3 a year from now? We find that people tend to say, I will discount the future value, the future greater
value, to present value and its called
hyperbolic discounting because that discounting essentially brings us
back to what is the value today, completely
discount it. So, how is this how is this relevant? Well, let me know talk about a different concept or
related concept for a second. That is in the future, will power is irrelevant. In the future we always do the right thing, or where its perceived generally as the right thing. In the future we always eat better. In the future we weigh less. In the future, we work out more, we save more, we inv est in more equity if that’s what you value
system is. When decisions have to be made today, and they are going to impact us immediately, we tend to return to what we prefer to do with
that time. For example, there is a famous example of people were asked to decide at a business conference, what would you like
to be your break time snack a week from
now? You can choose between sweets or more nutritious fruits and vegetables. A separate group was asked what if the decision is not going to affect you a
week from now but it’s going to affect the brain coming up in twenty minutes. We found that when the decision was, I’m going to affect you or was framed as being a week from now, that
people tended to pick the more nourishing snack, fruits and vegetables,
and much less likely to pick the candies and sweets. However, when people were told your snack choice will be delivered to you within 20 minutes at the break, people almost completely switched over to picking the sweets and the candy over the nutritious snack. Its just we tend
to look at what effects us
immediately as opposed to looking out into the
future. This is an important issue particularly when it relates to retirement savings. That is, we can talk to people about how their savings dollars they’re putting away today are going to be worth five times,
ten times more by the time they retire. However, the participant or the employee tends to
look at that and say, I’m going to discount hyperbolicly that five-time gain in the future forty years from
now, let’s say, back to present value in now my putting
money away into the savings plan is actually
perceived as a loss that I have less are spending power is less immediate gratification that I
can have. And so hyperbolic discounting can be
extremely powerful and in causing us to make sub-optimal decisions because we’re forfeiting, or we typically intend to forfeit small
immediate gains for larger rewards in the future, but we often fail to make the optimal choice at decision time.

3 thoughts on “Behavioral Finance (BeFi) – Hyperbolic Discounting

  1. I have seen videos referring to an agent's "discount value". The video said that typically people have a "discount value" of 0.8, where a discount value of 1 means that the person valued $2 now just as much as they value $2 tomorrow or even a year from now and a discount value of 0 means that the person has absolutely no value of the future what so ever. Obviously d=1 and d=0 are beyond human limits.

    Have you come across this metric?

    Thanks,
    R

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