How Good is the Exponential Function Discounting Formula?: An Experimental Study
44 Pages Posted: 27 Jun 2003
Date Written: June 2003
This paper estimates the degree of the exponential-function misvaluation, its variation with given product price level, and its expected growth rate. The paper examines whether other mathematical functions, such as linear, quadratic and cubic functions, conform to the discounting and compounding processes of individual decision makers. Using subjects familiar with the exponential function discounting formula, this study finds that individuals undervalue the compound interest discounting formula given by the exponential function and overvalue the simple interest discounting formula given by the linear function. These findings can be attributed to the overreaction, overconfidence, mental accounting and narrow-framing behaviors discussed in psychology.
Keywords: Exponential Discount Function, Experimental Subjective Discount Rates, Linear, Quadratic and Cubic Functions, Overreaction, Overconfidence, Mental Accounting and Narrow-Framing Behavior, Economic Psychology
JEL Classification: D90, G00
Suggested Citation: Suggested Citation