# DP2503 Subjective Discount Factors

Author(s): | Erzo G J Luttmer, Thomas Mariotti |

Publication Date: | July 2000 |

Keyword(s): | Asset Pricing, Consumption-Wealth Ratios, General Equilibrium, Hyperbolic Discounting, Volatility |

JEL(s): | D50, D91, G12 |

Programme Areas: | Financial Economics |

Link to this Page: | cepr.org/active/publications/discussion_papers/dp.php?dpno=2503 |

This paper describes the equilibrium of a discrete-time exchange economy in which consumers with arbitrary subjective discount factors and quasi-homothetic period utility functions follow linear Markov consumption and portfolio strategies. Explicit expressions are given for state prices and consumption-wealth ratios. If utility is logarithmic or endowment growth is i.i.d., then this economy is observationally equivalent to one in which consumers discount geometrically. We provide analytically convenient continuous-time approximations and examine the effects of non-geometric subjective discount factors in an economy in which log endowments are subject to temporary and permanent shocks that are governed by a Feller (1951) square-root process. Hyperbolic and quasi-hyperbolic discount factors can significantly increase the volatility of aggregate wealth and raise the expected excess return on aggregate wealth.