Subjective random discounting and intertemporal choice

This paper provides an axiomatic foundation for a particular type of preference shock model, called the random discounting representation, where a decision maker believes that her discount factors change randomly over time. For this purpose, we formulate an infinite horizon extension of Dekel, Lipman, and Rustichini (2001), and identify the behavior that reduces all the subjective uncertainties to those about future discount factors. We show uniqueness of subjective belief about discount factors. Moreover, a behavioral comparison about preference for flexibility characterizes the condition that one’s subjective belief second-order stochastically dominates the other’s. Finally, the resulting model is applied to a consumption-saving model and to an optimal stopping problem.