A new test of convexity-concavity of discount function (Q2202224)

Let us denote streams of three intertemporal payoffs by three-outcome vectors. The first outcome is the payoff at the time \(t=0\), the second is the payoff at time \(t=1\) and the third outcome is the payoff at the time \(t=2\). Therefore the stream \(S=(z_0,z_1,z_2)\) yields \(z_0\) now, \(z_1\) at time \(t=1\) and \(z_2\) at time \(t=2\). It is assumed that preferences are represented according an additively separable utility \[ U(z_0,z_1,z_2)=u(z_0)+D(1)u(z_1)+D(2)u(z_2), \] where \(D\) is a discount function, and \(u\) is a time-invariant utility function. The authors of the paper analyse a binary choices between streams: \(\{(x,y,0), (y,0,x)\}\) and \(\{(x,0,y), (0,y,x)\}\). They present a new simple test of convexity-concavity of the discount function based on these binary choices.