The “Weitzman-Gollier puzzle" is not a paradox but a mistake, and it is most likely moot

by Open Science Repository Economics
(October 2013)

Abstract

The “Weitzman-Gollier puzzle” refers to the observation that, when interest rates are uncertain, the expected values of discount factors and compound factors for a pair of present and future values yield different certainty-equivalent discount rates, which are either decreasing or increasing as a function of time, and either tend to the lowest or to the highest possible interest rate. There were many attempts to both resolve this apparent paradox and to justify the conclusion that discount rates should be declining in the long term, but none explained why the certainty-equivalents diverge. The cause of the divergence was found to be Weitzman’s incorrect formulation of the expected discount factor in his 1998 article. Correcting for this, the puzzle disappears, and Weitzman’s model shows that discount rates should be increasing in the long term. However, the entire question is moot, as it depends on annual interest rates displaying nearly perfect autocorrelation.

Keywords: discount rate, uncertainty, declining discount rate, benefit-cost analysis.

Full text

The “Weitzman-Gollier puzzle" is not a paradox but a mistake, and it is most likely moot