The missing link: unifying risk taking and time discounting

Abstract

Standard economic models view risk taking and time discounting as two independent dimensions of decision makers' behavior. However, mounting experimental evidence demonstrates the existence of robust and systematic interaction effects. There are striking parallels in patterns of risk taking and time discounting behavior, which suggests that there is a common underlying force driving these interactions. Here we show that decision makers' anticipation of something going wrong in the future conjointly with their proneness to probability weighting generates a unifying framework for explaining seven puzzling regularities: delay-dependent risk tolerance, aversion to sequential resolution of uncertainty, preferences for resolution timing, hyperbolic discounting, subadditive discounting, the differential discounting of risky and certain outcomes, and the order dependence of prospect valuation. Finally, we discuss the implications of our framework for understanding real-world behavior, such as the coexistence of underinsuring and overinsuring.