WP 2011-01 Discounting Behavior and the Magnitude Effect

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Published in 2013 in Economica, Volume 80, Issue 320.

ABSTRACT. We evaluate the claim that individuals exhibit a magnitude effect in their discounting behavior, which is said to occur when higher discount rates are inferred from choices made with lower principals, all else being equal. If the magnitude effect is quantitatively significant it is not appropriate to use one discount rate or discounting function, independent of the scale of the project, for the purposes of cost-benefit analysis and capital budgeting. If the effect is robust, as claimed, we should be able to see it using procedures that are more familiar to economists. Using data collected from a field experiment in Denmark, we find statistically significant evidence of a small magnitude effect, at levels that are much smaller than is typically claimed. This evidence only surfaces if one carefully controls for unobserved individual heterogeneity in the population.