A Theory of Intermediated Investment with Hyperbolic Discounting Investors

A Theory of Intermediated Investment with Hyperbolic Discounting Investors GAO Feng (Tsinghua SEM) HE Ping (Tsinghua SEM) HE Xi (MIT Economics)

GAO Feng (Tsinghua SEM) HE Ping (Tsinghua SEM) HE Xi (MIT Economics)

P reface CR A Long time ago, a visitor from out of town came to a tour in Manhattan. At the end of the tour they took him to the financial district. When they arrived to Battery park the guide showed him some nice yachts anchoring there, and said, here are the yachts of our bankers and stockbrokers. And where are the yachts of the investors? asked the naive visitor

  A long time ago, a visitor from out of town came to a tour in Manhattan. At the end of the tour they took him to the financial district. When they arrived to Battery Park the guide showed him some nice yachts anchoring there, and said, "Here are the yachts of our bankers and stockbrokers." "And where are the yachts of the investors?" asked the naive visitor. Preface

Investment c& Investment decisions are intertemporal choices involvin g tradeoffs among costs and benefits occurring at different times, which not only affect one 's health, wealth, and happiness, but may also determine the economic prosperity of nations CR Fisher(1930): investment is not an end in itself but rather a process for distributing consumption over time cR Major concerns: return, risk, information acquisition, life cycle, liquidity constraint, risk preference, background risk, etc

  Investment decisions are intertemporal choices involving tradeoffs among costs and benefits occurring at different times, which not only affect one's health, wealth, and happiness, but may also determine the economic prosperity of nations  Fisher (1930): investment is not an end in itself but rather a process for distributing consumption over time  Major concerns: return, risk, information acquisition, life￾cycle, liquidity constraint, risk preference, background risk, etc. Investment

Related studies CR Samuelson(1969, REStat), Merton(1969, REStat): dynamic programming with uncertainty CR Ehrlich and Hamlen( 1995, JEDC) precommitment strategy with intermittent revision CR Campbell and Viceira(1999, QJE): time varying Investment opportunities CR Viceira(2001, JF): background risk, life-cycle CR Gollier(2002, JME): Liquidity constraint, decreasing aversion to risk on wealth R Chacko and viceira(2005, RFS): incomplete market with stochastic volatility

  Samuelson (1969, REStat), Merton (1969, REStat): dynamic programming with uncertainty  Ehrlich and Hamlen (1995, JEDC): precommitment strategy with intermittent revision  Campbell and Viceira (1999, QJE): time varying investment opportunities  Viceira (2001, JF): background risk, life-cycle  Gollier (2002, JME): Liquidity constraint, decreasing aversion to risk on wealth  Chacko and Viceira (2005, RFS): incomplete market with stochastic volatility Related Studies

Empirical Facts oR Investment behaviors are more complex than what most standard theories could explain C3 Barber and odean(2002, RFS): online trading make investors trade more actively but less profitable C3 Barnea, Crongvist and Siegel(2010, JFE): genetic factor is critical for investor behavior C He and Hu (2010, RBF): horizon effect C3 Mastrobuoni and Weinberg(2009, AEj-EP: consumptions are not smoothed C3 Meier and Sprenger(2010, AEJ-AE): individuals with present-biased preference over-borrow on their credit cards

  Investment behaviors are more complex than what most standard theories could explain  Barber and Odean (2002, RFS): online trading make investors trade more actively but less profitable  Barnea, Cronqvist and Siegel (2010, JFE): genetic factor is critical for investor behavior  He and Hu (2010, RBF): horizon effect  Mastrobuoni and Weinberg (2009, AEJ-EP): consumptions are not smoothed  Meier and Sprenger(2010, AEJ-AE): individuals with present-biased preference over-borrow on their credit cards Empirical Facts

Behavioral Theories and investment CR Barberis &z huang(2001, JF): mental accounting and loss aversion CR Angeletos, Laibson, Repetto, Tobacman and Weinberg (2001, JEP); Harris laibson(2001, Econometrica) Salanie and Treich(2006, EER): hyperbolic discounting cR Grenadier &z wang(2007, JFE): real options investment model with hyperbolic discounting entrepreneurs CR Munk(2008, JEDC): habit formation

  Barberis & Huang (2001, JF): mental accounting and loss aversion  Angeletos, Laibson, Repetto, Tobacman and Weinberg (2001, JEP); Harris & Laibson (2001, Econometrica); Salanie and Treich (2006, EER): hyperbolic discounting  Grenadier & Wang (2007, JFE): real options investment model with hyperbolic discounting entrepreneurs  Munk (2008, JEDC): habit formation Behavioral Theories and Investment

Hyperbolic Discounting CR Frederick, Loewenstein and O Donoghue(2002, JEL): given two similar rewards, humans show a preference for one that arrives sooner rather than later, but valuations fall very rapidly for small delay periods, but then fall slowly for longer delay periods 1.0 k10 0.8 0.8 50.6 0.6 0.4 04 02 0.2 0.0 0 5 15 time horizon(years) time horizon (years) igure la. Discount Factor as a Function of Time Figure lb. Discount Factor as a Function of Time Horizon(all studies Horizon(studies with avg horizons I year

  Frederick, Loewenstein and O’Donoghue (2002, JEL): given two similar rewards, humans show a preference for one that arrives sooner rather than later, but valuations fall very rapidly for small delay periods, but then fall slowly for longer delay periods Hyperbolic Discounting

Facts Related to Hyperbolic Discounting CR Time inconsistent preferences, implying a motive for consumers to constrain their own future choices (Laibson, QJE 1997) C Under-saving(Laibson, EER 1998; Diamond and Koszegi PubE 2003 Salanie and Reich, EER 2006) C3 Over-borrowing(Heidhues and Koszegi, AER 2010 C3 Use of commitment device(Basu, AEJ-Micro 2011)

  Time inconsistent preferences, implying a motive for consumers to constrain their own future choices (Laibson, QJE 1997)  Under-saving (Laibson, EER 1998; Diamond and Koszegi, JPubE 2003; Salanie and Treich, EER 2006)  Over-borrowing (Heidhues and Kőszegi, AER 2010)  Use of commitment device (Basu, AEJ-Micro 2011) Facts Related to Hyperbolic Discounting

The role of Intermediaries for Investors CR Information production: He(2007, RFS); Gorton and He (2008,RES) CR Monitoring: Diamond (1984, RES CR Screening: Bernanke and Blinder(1988, AER CR Liquidity provider: Diamond and Dybvig(1983, JPE CR Risk transformation: Diamond(1984, RES CR Maturity transformation: Diamond and Dybvig(1983, JPE CR Payment methods: He, Huang and Wright(2005, IER)

  Information production: He (2007, RFS); Gorton and He (2008, RES)  Monitoring: Diamond (1984, RES)  Screening: Bernanke and Blinder (1988, AER)  Liquidity provider: Diamond and Dybvig (1983, JPE)  Risk transformation: Diamond (1984, RES)  Maturity transformation: Diamond and Dybvig (1983, JPE)  Payment methods: He, Huang and Wright (2005, IER) The Role of Intermediaries for Investors

Goal of This Paper cR Time inconsistent preference generates a liquidit shortage for the investor who invests on his own c& Financial intermediaries make investments on behalf of the investors and provide liquidity for unsophisticated investors sR The financial intermediaries in our model can be interpreted as banks, pension funds, mutual funds etc

  Time inconsistent preference generates a liquidity shortage for the investor who invests on his own  Financial intermediaries make investments on behalf of the investors and provide liquidity for unsophisticated investors  The financial intermediaries in our model can be interpreted as banks, pension funds, mutual funds, etc. Goal of This Paper