Working Paper: NBER ID: w30822
Authors: David Laibson; Peter Maxted
Abstract: When solving discrete-time consumption models with present-biased time preferences, backwards induction generates equilibria that are non-robust in the sense that policy functions are often sensitive to parameter choices, including the modeler's choice of the time-step. The current paper identifies a range of "sweet-spot" time-steps that (i) contains the psychologically relevant present bias horizons, and, (ii) generates numerically indistinguishable (i.e., robust) policy functions. This sweet spot includes both a computationally feasible range of discrete-time cases and the limiting continuous-time case (Harris and Laibson, 2013). Accordingly, researchers modeling present bias in buffer stock models can choose either discrete-time cases calibrated to be in the sweet spot or the analytically tractable continuous-time case; these approaches yield essentially identical policy functions.
Keywords: No keywords provided
JEL Codes: C6; D15; D9
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| choice of timestep (C69) | robustness of policy functions (E61) |
| larger timesteps (C41) | non-robust consumption predictions (E21) |
| smaller timesteps (C69) | robust policy functions (E61) |
| timestep approaching sweet spot (C41) | robustness of predictions (C52) |
| increase in wealth (E21) | decrease in consumption (E21) |