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Cognitive bias: Time preference.

Is Your Dollar Worth More Today?

The Marshmallow effect in our neurons!

What would have been your worst torture in your childhood?

Perhaps the Marshmallow test!

Let’s imagine you are given a marshmallow and asked to wait for 10 minutes to get another one under the condition that you do not eat the original marshmallow.

Look at the video below to discover this famous psychological experiement!

Adults are rarely much more mature!

We tend to prefer immediate reward than future rewards, even if the future rewards are higher. Many experiments have shown that most animals have the same behavior.

Neural correlations have been found through various fMRI experiments to give a biological explanation of this biased behavior. Most of the time, participants have made a series of choices between immediate and future monetary reward while researchers were studying the activation of their brain.

They found that when making such choices, let’s say between winning 10 dollars today or 20 dollars in three months, two parts of our brain were competing.

Our parietal cortex, more sensitive to numbers, time and space magnitudes, ”wants” to be rewarded immediately while our striatum, in charge of reward evaluation, ”wants” the higher reward.

For many of us, the parietal cortex has the advantage over our reward system so that we prefer a lower immediate reward rather than waiting to get a better one.

How to model our inter-temporal choices?

Inter-temporal choice is the study of the relative value people assign to two or more payoffs at different points in time, like getting one marshmallow right now or waiting to get another one.

Most choices require decision-makers to trade-off costs and benefits at different points in time.

In one of the major contributions to behavioral economics, Loewenstein and Prelec (1992) set the foundation for this behavioral approach to decision making over time. Several models have followed (Laibson, Samuelson, Ebert and Prelec…).

They found that we do make the same inter-temporal choices in the case of gains or losses. If we have the choice between paying €300 now or €400 in one year (supposing that we do not invest this money) , we will tend to postpone this unpleasant event even if we have to pay more later.

On the contrary, as for the children in the marshmallow experiment, we will prefer to get the €300 now rather than waiting one year to get the €400. Human brains tend to procrastinate.

Moreover, we tend to overvalue very immediate rewards. We prefer to buy higher delivery fees to get our new phone the soonest as possible. This bias is called present bias.

What is the impact of cognitive time discounting on investment decisions?

Most investment decisions are made for the middle or long run. Investing in a stock, in an acquisition, or in an industrial project is betting on the future. Time preferences biases highly affect such financial decisions.

References:
Parieto-temporal activation modulates pure time preference. Wegener, J., Madsen, K., Christensen, M. S., & Jamison, J. (2008)
Kable, J. W., & Glimcher, P. W. (2007). The neural correlates of subjective value during intertemporal choice. Nature neuroscience, 10(12), 1625-1633.

McClure, S. M., Laibson, D. I., Loewenstein, G., & Cohen, J. D. (2004). Separate neural systems value immediate and delayed monetary rewards. Science, 306(5695), 503-507.
Loewenstein, G., & Prelec, D. (1992). Anomalies in Intertemporal Choice: Evidence. Choice over time, 119.

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