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Habits and anomalies in intertemporal choice

Authors Wathieu, Luc
Issue Date 1995-09
Summary This paper analyzes a model of discounted utility under habit formation. Habit formation means that utility in each period is determined by the difference between the received outcome and the customary outcome at that point in time. Preferences are rational, in the sense that the decision maker correctly anticipates the habit formation process and behaves in a dynamically consistent manner (i.e., plans are truly carried out). The purpose is to demonstrate that this simple generalization of the discounted utility model accounts, in a meaningful way, for the most striking anomalies with respect to classical discounted utility theory. We explain the so-called common difference effect (intertemporal trade-offs are time-dependent), which has usually been viewed as evidence against exponential discounting. We also examine the frequently observed preference for increasing sequences of outcomes, which has been regraded as a case of negative discounting. A discussion of the descriptive, prescriptive and normative value of the model is included.
Language English
Format Working paper
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