Intertemporal Capital Allocation Decisions in the Low Interest Rate Environment

Abstract

THE AIMS OF THE PAPER

In this study, we investigate the impact of the low interest rate environment on the investment decisions. By formulating our research question, we wanted to know what kind of decision rule could describe the intertemporal preferences of decision makers in the low interest rate environment, if the traditional present value rule cannot explain the outcome of the decisions.

METHODOLOGY

To answer this research question we made a literature review and used numeric examples to introduce the rationally expected reaction of the decision makers. We also compared the intertemporal choices of decision makers who apply the traditional present value rule with those who have short-term preferences. During the research, we investigated the reactions of the decision makers mainly from a methodological point of view and we concentrated on the intertemporal preferences using the assumption that the reactions of the decision makers are motivated by the present value rule. We investigated the last decade after the crisis, because it is a distinct period, which enabled us to introduce the changes induced by the low interest rate environment.

MOST IMPORTANT RESULTS

By applying the traditional present value rule, we showed that the decrease of the discount rate stretches the time horizon of the investments and the increasing volatility of the present value provide space for speculation and for chase of returns. As the most important result of our research, we argue that in the cases when the traditional present value rule cannot explain the intertemporal preferences of decision makers we can apply quasi-hyperbolic discount functions, which can explain the decrease of investments and the increase of capital transfers. In the case of decision makers with short-term preferences the excess discounting leads to lower present values compared to the traditional present value rule, thus these decision makers can forgo valuable investment.

RECOMMENDATIONS

To answer our research question, we can draw the conclusion, that hyperbolic discounting and quasi-hyperbolic discount functions emerge as an alternative decision making framework of the intertemporal capital allocation decisions in contrast of the traditional present value rule in the low interest rate environment.