Risk in Time: The Intertwined Nature of Risk Taking and Time Discounting

Standard economic models view risk taking and time discounting as two independent dimensions of decision makers’ behavior. However, mounting evidence demonstrates the existence of robust and systematic interaction effects and there are striking parallels in patterns of risk taking and time discounting behavior which suggest that there could be common underlying forces driving these interactions. Here we show that the inherent uncertainty associated with future prospects together with individuals’ proneness to non-linear probability weighting generates a unifying framework for explaining a large number of puzzling behavioral regularities: delay-dependent risk tolerance, aversion to sequential resolution of uncertainty, preferences for the timing of the resolution of uncertainty, the differential discounting of risky and certain outcomes, hyperbolic discounting, subadditive discounting, and the order dependence of prospect valuation. Finally, we show that our framework also explains why people often simultaneously under-insure large risks and over-insure small risks.