Definition
Hyperbolic discounting is a pattern of time preference in which the rate at which individuals discount future outcomes declines as the delay grows longer, producing a stronger preference for the near term over the medium term than for the medium term over the far term.
Why it matters
Hyperbolic discounting is the math-based characterization of the time-preference pattern that underlies present bias, and it provides the framework within which economists and decision scientists model why participants systematically save less than they intend and defer decisions about lifetime income. The pattern predicts the specific kind of preference reversal observed in laboratory and field studies. It gives the intuitive observation that individuals are "impatient in the short run and patient in the long run" a precise structural form that can be applied consistently across contexts.
How it works
Under the constant discounting assumed in classical economic models, a delay of a given length reduces the value of a future outcome by the same proportion no matter when the delay occurs, so the ratio of the value of an outcome at time A to the same outcome at time B depends only on the length of the interval between A and B. Under hyperbolic discounting, that ratio depends on when the interval occurs, with intervals nearer to the present producing larger reductions in value than intervals of the same length farther out. A common illustration: a person who prefers to receive one hundred dollars today rather than one hundred and ten dollars in a week may, when the same choice is set fifty-two weeks in the future, prefer to wait the extra week for the larger amount, revealing that the one-week interval carries much greater weight when it begins today than when it begins a year from now. The pattern produces choices that reverse as time passes, and it is the structural form that gives rise to the observed present-bias phenomenon.
In practice
The participant is unlikely to identify hyperbolic discounting directly in personal choices, since the discounting is not consciously computed. Practical recognition instead takes the form of noticing repeated postponement of decisions that a longer view would treat as worth acting on now, such as increasing plan contributions or purchasing a deferred income annuity. One useful practice is to accept that the near-term discount will resurface each time a decision is deferred and to use commitment structures that remove the decision from the near-term frame, including automatic enrollment, automatic escalation, and precommitted purchases of future income streams. Questions to raise with a professional include which retirement-plan features and product structures function as commitment devices, and how the participant's own history of intended-but-deferred actions can be used to select structures that reduce the number of near-term decision points.
In the Longevity Standard Framework
Hyperbolic discounting enters the Longevity Standard framework as the structural characterization of the time-preference pattern that produces present-biased savings and lifetime income decisions, and it operates upstream of any lifetime income analysis, affecting the accumulated balance a participant carries into retirement.
Related terms
- Present bias
- Time preference
- Discount rate
- Deferral multiplier
- Commitment device
- Automatic escalation
- Expected utility theory