Behavioral biases in intertemporal decisions
Year: 2013
Type: dissertation
Abstract: Modeling intertemporal decisions is essential to understand many financial decisions both at the household and at the company level. Most of the time, these decisions are very complicated and it is very difficult to develop a single model that can describe the intertemporal decision making process in different contexts. Still, this does not prevent many researchers from attempting to understand preferences of individuals in intertemporal decision setting, since people face intertemporal decisions very often. For intertemporal decision modeling, we can distinguish between two different types of theories: normative and descriptive. Normative theories try to explain how decision makers ought to approach to intertemporal decisions and they derive simple guidelines for rational decision making. The most renowned normative theory tackling intertemporal decision process is the standard discounted expected utility (DEU), which basically consists of two parts: expected utility theory and constant subjective discount rates. Despite its normative quality, expected utility theory is unable to describe the human decision process accurately in many cases, as it emanates from unbounded rationality. In reality, we observe deviations from rational human image that lead to certain unexplained puzzles such as the disposition effect or the equity premium puzzle. These puzzles can only be explained by alternative theories that integrate decision biases resulting from bounded investor rationality into the decision making process. Descriptive theories simply intend to fill this gap and explain the actual preferences in intertemporal decisions. This point sets up the motivation of this dissertation, as we analyze the relevance of these descriptive decision theories in actual intertemporal decision settings in the fields of corporate and household finance. We begin with a brief introduction presenting the standard discounted expected utility (DEU) theory that aims to solve the intertemporal decision problem. Consequently, we discuss the deviations from the assumptions of DEU model that are revealed by numerous studies. After this detailed motivation, we analyze the implications of these deviations from DEU model for corporate and household finance in four papers. We specifically focus on the relation between decision anomalies and dividend policy, cash policy, saving/borrowing decisions and credit spreads in P2P markets. Generally, we use the following approach in each one of our papers: After a brief introduction, we develop hypotheses connecting the behavioral biases to our research question based on a (mathematical) theoretical framework. Consequently, we conduct experiments in settings resembling the actual intertemporal decision process that we want to analyze. Based on these results, we investigate the connection between the behavioral biases revealed in experiments and intertemporal decisions in different scenes of corporate and household finance. In all four papers, the empirical results clearly suggest that DEU model is incapable of explaining the decision process in intertemporal setting completely and it should be extended utilizing the findings obtained in experiments analyzing human decision process from a psychological perspective. In sum, in all four papers, we reach the conclusion that the limited rationality of investors and the resulting biases identified in experiments shape the intertemporal decision process both in the fields of corporate and household finance. Furthermore, we study new behavioral patterns modifying the designs of some well-known experimental studies and demonstrate that our experiments reflect the actual preferences of individuals quite accurately. Thus, based on this work, we find supporting evidence for the general assumptions of the “Behavioral Finance” story. Additionally, our experiments also strengthen the view defending the relevance of experiments in economics, as not many researchers try to bridge the gap between “Experimental Economics” and “Household Finance”.
Authors: K. Can Soypak, Wolfgang Breuer
Language: English
Subfield: General Decision Sciences
Field: Decision Sciences
Domain: Social Sciences
Open Access status: green
OpenAlex ID: W2625774976