Failure of Smooth Pasting Principle and Nonexistence of Equilibrium Stopping Rules under Time-Inconsistency

TL;DR

This paper investigates the limitations of the smooth pasting principle in time-inconsistent stopping problems caused by non-constant discount rates, showing it often fails and no equilibrium exists in such cases.

Contribution

It demonstrates that the smooth pasting principle cannot be generally applied to time-inconsistent problems and provides conditions under which it fails, highlighting the need for alternative methods.

Findings

Smooth pasting principle may fail under time-inconsistency.

Failure occurs even with simple non-exponential discount functions.

No intra-personal equilibrium exists when smooth pasting fails.

Abstract

This paper considers a time-inconsistent stopping problem in which the inconsistency arises from non-constant time preference rates. We show that the smooth pasting principle, the main approach that has been used to construct explicit solutions for conventional time-consistent optimal stopping problems, may fail under time-inconsistency. Specifically, we prove that the smooth pasting principle solves a time-inconsistent problem within the intra-personal game theoretic framework if and only if a certain inequality on the model primitives is satisfied. We show that the violation of this inequality can happen even for very simple non-exponential discount functions. Moreover, we demonstrate that the stopping problem does not admit any intra-personal equilibrium whenever the smooth pasting principle fails. The "negative" results in this paper caution blindly extending the classical approaches for time-consistent stopping problems to their time-inconsistent counterparts.