Discounting When Income is Stochastic and Discounted Utility Anomalies

Abstract

Several discounted utility anomalies are explained as rational choices of an agent with standard preferences and stochastic income. We define the term structure of absolute risk aversion and demonstrate that the gain-loss asymmetry is observed for small gains and losses and a general utility function if the term structure is non-decreasing. Agents, whose current income is less than the long-run average by a certain margin, exhibit hyperbolic discounting. The discount rate of agents, whose current income is above the central tendency, is increasing. Agents who are neither rich nor poor have hump-shaped discount rate curves.