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Understanding the Reverse Effects of Discount Rates on Losses: Insights from Behavioral Economics

This research paper, authored by David Hardisty, Kirstin Appelt, and Elke Weber, explores how discount rates for losses differ from gains and exhibit reverse direction and magnitude effects. It delves into the implications of discounting, highlighting how people exhibit impatience more intensely when faced with losses than with gains. The study presents findings from two main experiments that investigate the relationships between sign, magnitude, and direction effects on decision-making. Key insights reveal that decision patterns are influenced by immediate versus future costs, impacting savings and behavior.

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Understanding the Reverse Effects of Discount Rates on Losses: Insights from Behavioral Economics

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  1. I want it now! Why discount rates for losses show reverse direction and reverse magnitude effects David Hardisty, Kirstin Appelt, & Elke Weber Columbia University NSF SES-0345840 & SES-0820496 NIA 5R01AG027934-02

  2. Co-Authors Kirstin Appelt Elke Weber

  3. Why study discounting? • Insufficient savings (Thaler & Benartzi, 2004) • Unhealthy behavior (Bickel et al., 1999) • Depletion of environmental resources (Hendrickx et al., 2001) • All involve myopic tradeoffs between immediate and future costs and benefits • Discounting the future means we want gains now and losses later

  4. Discounting “Anomalies” • Sign effect: losses discounted less (Thaler, 1981; Hardisty & Weber, 2009) • Magnitude effect: large outcomes discounted less (Thaler, 1981) • Direction effect: more discounting when you delay than when you accelerate (Loewenstein, 1988; Weber et al., 2007)

  5. Reversals • Direction and magnitude effects are eliminated or reversed for losses (Benzion et al., 1989; Shelley, 1993) Unfortunately, forgotten. Why? • Don’t fit standard models • No process data

  6. Reconceptualizing Impatience • Impatience is “irrational” disutility of waiting • for gaining $100: I want it now • for losing $100: I want to get it out of the way now (Loewenstein, 1987) • Impatience is relatively insensitive to outcome magnitude (Benhabib et al., 2007) • This explains the sign effect, magnitude effect, direction effect, and their interactions

  7. Implications • For gains, impatience means more discounting • For losses, impatience means less discounting

  8. Explaining the Sign Effect • Get $1,000 now or $1,000 next year?+ uncertainty (Weber & Chapman, 2005; Epper et al., 2009)+ resource slack (Zauberman & Lynch, 2005)+ interest on investment (e.g., Franklin, 1784; Samuelson, 1937)+ impatience (Laibson, 1997) high discount rate • Pay $1,000 now or $1,000 next year?+++ other factors - impatience  lower discount rate

  9. Outline • Study 1: Sign, Magnitude, and Sign X Magnitude • Study 2: Sign, Direction, and Sign X Direction • Thought listings • National samples • Between-subjects designs

  10. Study 1 Sign X Magnitude

  11. Study 1: Participants • 199 US residents, recruited and run online • 76% female • Range of ages, education, & income • $8 compensation

  12. Study 1: Gain Scenario • Imagine there was a legitimate error on your back taxes in your favor, and you will immediately receive$10 [$10,000] from the government. • However, they are also giving you the option of receiving a different amount one year from now, instead. How much would the future amount need to be for you to choose it?

  13. Study 1: Loss Scenario • Imagine there was a legitimate error on your back taxes against you, and you must pay the government $10 [$10,000] immediately • However, they are also giving you the option of paying a different amount one year from now, instead. How much would the future amount need to be for you to choose it?

  14. Thought Listing

  15. Study 1: Choices

  16. Discount Parameter V = A / (1 + kD) k = (amount later - amount now) amount now * delay • Increasing number indicates more discounting (Mazur, 1987)

  17. Study 1: Results 1.2 1 0.8 0.6 $10 mean k $10,000 0.4 0.2 0 Gain Loss -0.2

  18. Explaining the Magnitude Effect for Gains • Impatience is insensitive to magnitude • Therefore, impatience has relatively less influence on large magnitude outcomes • Lower discount rates for larger magnitudes

  19. Study 1: Results 1.2 1 0.8 0.6 $10 mean k $10,000 0.4 0.2 0 Gain Loss -0.2

  20. Study 1: Results 1.2 1 0.8 0.6 $10 mean k $10,000 0.4 0.2 0 Gain Loss -0.2 Sign: B = .45, p < .001; Magnitude: B = -.11, p = .07; Sign X Magnitude: B = -.22, p = .001

  21. Explaining the Magnitude Effect for Losses • Impatience (to get it out of the way) is insensitive to magnitude • Therefore, impatience has relatively less influence on large magnitude outcomes • Higher discount rates for larger magnitudes

  22. Thought Coding Six categories: • Future uncertainty • Expecting the money will be more useful now than in the future • Earning interest on investments • Other: what you ought to do (for example, “I should wait”) • Other: what you want (for example, “I want it now to get it over with”) • None of the above

  23. Thought Coding Six categories: • Future uncertainty • Expecting the money will be more useful now than in the future • Earning interest on investments • Other: what you ought to do (for example, “I should wait”) • Other: what you want (for example, “I want it now to get it over with”) • None of the above

  24. Want Now Thoughts 0.4 0.35 0.3 0.25 $10 Mean proportion want now thoughts 0.2 $10,000 0.15 0.1 0.05 0 Gain Loss Sign: B = -.26, p < .001; Magnitude: B = -.20, p < .01; Sign X Magnitude: B = .06, p = ns

  25. Process Summary • Gains: greater magnitude  less impatience  less discounting • Losses: greater magnitude  less impatience  more discounting

  26. Study 1: Mediation for Gains Proportion of “Want now” Thoughts β = -.23, p <.05 β = + .19, p < .05 Magnitude Discounting (β = -.27, p < .01) β = -.23, p < .05 Bootstrapping Test p < .05

  27. Study 1: Mediation for Losses Proportion of “Want now” Thoughts β = -.21, p < .05 β = - .23, p < .05 Magnitude Discounting (β = .35, p < .001) β = .30, p < .01 Bootstrapping Test p < .05

  28. Study 1: Conclusions • Replicated sign & magnitude effects • Sign x Magnitude stronger than previous (within-subjects) studies • Want now thoughts mediate the magnitude effect for gains and losses • Impatience (as measured by want now thoughts) predicts discounting in opposite directions for gains and losses

  29. Study 2 Sign x Direction

  30. Direction Effect • Delay: default is today, with option to receive larger amount later • Accelerate: default is later, with option to receive smaller amount sooner • Greater discounting for delay than accelerate (Loewenstein, 1988)

  31. Explaining the Direction Effect • Creates a default for now or for later • People are initially biased in favor of the default option (Query Theory, Weber et al., 2007) • Subsequent thoughts are influenced by this bias • Default predicts the order and balance of thoughts, which predict choices (Query Theory, Weber et al., 2007)

  32. Explaining the Direction Effect • Creates a default for now or for later • People are initially biased in favor of the default option (Query Theory, Weber et al., 2007) • Subsequent thoughts are influenced by this bias • Default predicts the order and balance of thoughts, which predict choices (Query Theory, Weber et al., 2007)

  33. Explaining the Direction Effect • Creates a default for now or for later • People are initially biased in favor of the default option (Query Theory, Weber et al., 2007) • Subsequent thoughts are influenced by this bias • Default predicts the order and balance of thoughts, which predict choices (Query Theory, Weber et al., 2007)

  34. Reminder • For gains, impatience means greater discounting • For losses, impatience means lower discounting

  35. Study 2: Participants • 607 US residents • 75% women • Range of ages, education, & income • Same method as Study 1

  36. Study 2: Gain Scenarios • delay Imagine you have been selected to receive a $50 prize today. However, you also have the option of receiving a larger amount 3 months from now. • accelerate Imagine you have been selected to receive a $75 prize 3 months from today. However, you also have the option of receiving a smaller amount today.

  37. Study 2: Gain Scenarios • delay Imagine you have been selected to receive a $50 prize today. However, you also have the option of receiving a larger amount 3 months from now. • accelerate Imagine you have been selected to receive a $75 prize 3 months from today. However, you also have the option of receiving a smaller amount today.

  38. Study 2: Loss Scenarios • delay Imagine that you have been ticketed for a parking violation, and are required to pay $50 today. However, you also have the option of paying a larger amount 3 months from now. • accelerate Imagine that you have been ticketed for a parking violation, and are required to pay $75 3 months fromtoday. However, you also have the option of paying a smaller amount today.

  39. Study 2: Loss Scenarios • delay Imagine that you have been ticketed for a parking violation, and are required to pay $50 today. However, you also have the option of paying a larger amount 3 months from now. • accelerate Imagine that you have been ticketed for a parking violation, and are required to pay $75 3 months fromtoday. However, you also have the option of paying a smaller amount today.

  40. Study 2: Discounting 1.60 Delay Accelerate 1.20 0.80 k 0.40 0.00 -0.40 Gain Loss

  41. Study 2: Discounting 1.60 Delay Accelerate 1.20 0.80 k 0.40 0.00 -0.40 Gain Loss Sign: B = .34, p < .001 Direction: B = .07, p = .07 Sign X Direction: B = -.32, p < .001

  42. Study 2: Thought Coding

  43. Study 2: Thought Measure • Prominence of Now Thoughts (Cronbach’s α = 0.91) • Proportion of now thoughts • Proportion of later thoughts (reverse scored) • Order of thoughts Increasing number indicates more impatience

  44. Study 2: Thoughts 0.70 Delay 0.50 Accelerate 0.30 0.10 Prominence of Now Thoughts -0.10 -0.30 -0.50 -0.70 Gain Loss

  45. Study 2: Thoughts 0.70 Delay 0.50 Accelerate 0.30 0.10 Prominence of Now Thoughts -0.10 -0.30 -0.50 -0.70 Gain Loss Sign: B = -.36, p < .001 Direction: B = -.15, p < .001 Sign X Direction: B = -.06, p = .13

  46. Study 2: Mediation for Gains Prominence of “Now” Thoughts β = -.19, p = .006 β = +.62, p < .001 Direction Discounting (β = -.32, p < .001) β = -.23, p = .004 Sobel Z = -2.64, p = .008

  47. Study 2: Mediation for Losses Prominence of “Now” Thoughts β = -.08, p = .06 β = - .60, p < .001 Direction Discounting (β = .49, p < .001) β = .45, p < .001 Sobel Z = 1.89, p = .06

  48. Study 2: Conclusions • Replicate sign, direction, Sign x Direction • Now thoughts mediate direction effect for gains and losses • Impatience (as measured by now thoughts) predicts discounting in opposite directions for gains and losses

  49. General Conclusions • Impatience is “irrational” disutility of waiting • I want gainsnow • I want to get losses out of the way now

  50. General Conclusions Impatience • Explains Sign X Magnitude • Explains Sign X Direction • Sign is really important when thinking about discounting Greater discounting of gains Lower discounting of losses

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