Time-inconsistent preferences, investment and asset pricing

- We extend the production-based asset pricing model by incorporating time-inconsistent preferences.
- Time-inconsistent preferences induce under-investment, over-consumption and higher risk-free rate.
- The naïve agents consume more and invest less than the sophisticated agents.
- The interest rate in the economy with naïve agents is higher than that in the economy with sophisticated agents.

In this paper, we present a production-based asset pricing model in which agents have time-inconsistent preferences. We find that the time-inconsistent preferences lead to under-investment, over-consumption, and higher interest rate. These variables are distorted more in the economy with naive agent than the economy with sophisticated agent. In particular, the sophisticated agent invests more and consumes less than the naive agent, but invests less and consumes more than the time-consistent agent. The interest rate in the sophisticated agent economy is lower than that in the naive agent economy, but higher than that in the time-consistent agent economy.