# Presentation: 440650

## Neuroeconomics and Savings

- David Laibson
- Harvard University, Department of Economics
- and National Bureau of Economic Research
- April 1, 2006
*NIA Conference, Stanford University*

## Psychological Foundations A Thought Experiment

- Would you like to have
- 15 minute massage now
- 	or
- B)  20 minute massage in an hour
- Would you like to have
- C) 15 minute massage in a week
- 	or
- D) 20 minute massage in a week and an hour

## Read and van Leeuwen (1998)

*Time*

- Choosing Today

- Eating Next Week

- If you were
- deciding today,
- would you choose
- fruit or chocolate
- for next week?

## Patient choices for the future:

*Time*

- Choosing Today

- Eating Next Week

- Today, subjects
- typically choose
- fruit for next week.

- 74%
- choose
- fruit

## Impatient choices for today:

*Time*

- Choosing and Eating
- Simultaneously

- If you were
- deciding today,
- would you choose
- fruit or chocolate
- for today?

## Time Inconsistent Preferences:

*Time*

- Choosing and Eating
- Simultaneously

- 70%
- choose
- chocolate

## Instant Gratification and Movie DemandRead, Loewenstein & Kalyanaraman (1999)

- Choose among 24 movie videos
- Some are “low brow”: *Four Weddings and a Funeral*
- Some are “high brow”: *Schindler’s List*
- Picking for tonight: 66% of subjects choose low brow.
- Picking for next Thursday: 37% choose low brow.
- Picking for second Thursday: 29% choose low brow.
- Tonight I want sugar-coated entertainment...                next week I want things that are good for me.

## Outline:

- Modeling impulsivity
- Self-defeating behaviors
- Neuroimaging evidence and neuroeconomics

## Behavioral Model

- Quasi-hyperbolic discounting
- Phelps and Pollak (1968), Laibson (1997)
- Discounted utility function
- Ut = ut + 1⁄2ut+1 ut+2ut+3 
- Discounted utility from the perspective of time t+1.
-            Ut+1 =            ut+1 + 1⁄2ut+2 ut+3
- Discount function reflects dynamic inconsistency: preferences held at date *t* do not agree with preferences held at date *t+1*.

## Procrastination Akerlof 1991

- Suppose you can exercise (effort cost 6) to gain delayed benefits (health value 8).
- When will you exercise?
- Exercise Today:           -6 + 1⁄2 [8] = -2
- Exercise Tomorrow:      0 + 1⁄2 [-6 + 8] = 1
- Happy to make plans today to exercise tomorrow.
- But likely to fail to follow through.

## Self-defeating behaviors

- Patient activities many of us plan to do tomorrow:
- Watch less TV.
- Improve diet.
- Quit smoking.
- Floss.
- Comply with prescriptions.
- Exercise.
- Cut back credit card spending.
- Join retirement savings plan.

## Della Vigna and Malmendier (2004)

- Average cost of gym membership: $75 per month
- Average number of visits: 4
- Average cost per vist: $19
- Cost of “pay per visit”: $10

## Laibson, Repetto, and Tobacman (2004)

- Need impulsivity to explain lifecycle consumption facts:
- Substantial illiquid retirement wealth: W/Y = 3.9.
- But, extensive credit card borrowing:
- 68% didn’t pay their credit card in full last month
- Average credit card interest rate is 14%
- Credit card debt averages 13% of annual income
- Why do we see both saving and borrowing?!
- Patient long-run view leads us to set up automatic savings institutions (home mortgage, DB and DC pensions)
- Impatient short-run view leads us to postpone sacrifices to tomorrow, so we live hand to mouth, borrow on credit cards, and procrastinate

## Survey Evidence on ProcrastinationChoi, Laibson, Madrian, Metrick (2002)

- Survey
- Mailed to 590 employees (random sample)
- 195 usable responses
- Matched to administrative data on actual savings behavior
- Consider a population of 100 employees
- 68 report saving too little
- 24 of 68 plan to raise 401(k) contribution in next 2 months
- Only 3 of 24 actually do so in the next 4 months

## Active decisions: Choi, Laibson, Madrian, Metrick (2004) 

- Active decision mechanisms require employees to make an active choice about 401(k) participation.
- Welcome to the company
- You are *required* to submit this form within 30 days of hire, *regardless* of your 401(k) participation choice
- If you don’t want to participate, indicate that decision
- If you want to participate, indicate your contribution rate and asset allocation
- Being passive is *not* an option

## Slide 16

## 401(k) participation increases under active decisions

## Active decisions

- Active decision raises 401(k) participation.
- Active decision raises savings rates by 50%.
- Active decision doesn’t induce choice clustering.
- Under active decision, employees choose participation level and savings rates that they otherwise would have taken three years to achieve.

## Automatic enrollmentfirst studied by Madrian and Shea (2001)

- Welcome to the company
- If you don’t do anything
- You are automatically enrolled in the 401(k)
- You save 2% of your pay
- Your contributions go into a money market fund
- Call this phone number to opt out of enrollment or change your investment allocations

## Choi, Laibson, Madrian, Metrick (2004)

## Employees enrolled under automatic enrollment cluster at the default contribution rate.

**Employees enrolled under automatic enrollment cluster at the default contribution rate.**

- Default contribution
- rate under automatic
- enrollment

## Participants stay at the automatic enrollment defaults for a long time.

## Unsuccessful “solutions” to savings problems

- Paying employees to save:
- matches don’t work well
- Educating employees:
- financial education (alone) doesn’t work

## $100 Bills on the TableChoi, Laibson, Madrian (2004)

- Employer match is an instantaneous, riskless return on investment
- Particularly appealing if you are over 591⁄2 years old
-  Have the most experience, so should be savvy
-  Retirement is close, so should be thinking about saving
-  Can withdraw money from 401(k) without penalty
- We study seven companies and find that on average, _half_ of employees over 591⁄2 years old are not fully exploiting their employer match
-  Average loss is 1.6% of salary per year

## Financial education: Choi, Laibson, Madrian, Metrick (2004) 

- Seminars presented by professional financial advisors
- Curriculum: Setting savings goals, asset allocation, managing credit and debt, insurance against financial risks
- Seminars offered throughout 2000
- Linked data on individual employees’ seminar attendance to administrative data on actual savings behavior before and after seminar

## Treatment effect is positive but small

|  | Seminar attendees |  | Non-attendees |
| --- | --- | --- | --- |
|  | % planning to make change | % actually made change | % actually made change |
|  |  |  |  |
| Those not in 401(k) plan |  |  |  |
|   Enroll in 401(k) Plan | 100% | 14% | 7% |
| Those already in 401(k) plan |  |  |  |
|   Increase contribution rate | 28% | 8% | 5% |
|   Change fund selection | 47% | 15% | 10% |
|   Change asset allocation | 36% | 10% | 6% |

- Financial education effects are small
- Seminar attendees have good intentions to change their 401(k) savings behavior, but most do not follow through
- Financial education alone will not dramatically improve the quality of 401(k) savings outcomes
- We have also studied the effect of the Enron/Worldcom/Global Crossing scandals on employer stock holdings
- No net sales of employer stock in reaction to these news stories

## What is the underlying mechanism?

- Why are our preferences inconsistent?
- Is it adaptive?
- How should it be modeled?
- Does it arise from a single time preference mechanism (e.g., Herrnstein’s reward per unit time)?
- Or is it the resulting of multiple systems interacting (Shefrin and Thaler 1981, Bernheim and Rangel 2004, O’Donoghue and Loewenstein 2004, Fudenberg and Levine 2004)?

## Shiv and Fedorikhin (1999)

- Cognitive/deliberative mental processing resources manipulated by having people keep a 2-digit or     7-digit number in mind as they walk from one room to another
- On the way, subjects face choice between piece of cake or fruit-salad

| Processing burden | % choosing cake |
| --- | --- |
| Low (remember only 2 digits) | 37% |
| High (remember 7 digits) | 59% |

- "Heart and Mind in Conflict: Interplay of Affect and Cognition in Consumer Decision Making," *Journal of Consumer Research*, Vol. 26 (December 1999), 278-282.

## Limbic system

- vs. Fronto-Parietal System

- Limbic
- system

- Frontal
- cortex

- Parietal
- cortex

## McClure, Laibson, Loewenstein, and Cohen (2004)

- Do agents think differently about immediate rewards and delayed rewards?
- Does immediacy have a special emotional drive/reward component?
- Does emotional (limbic) brain value delayed rewards differently than the analytic (fronto-parietal cortex) brain?
- Specifically, does the limbic system discount the future at a greater rate than the fronto-parietal cortex?

## Subject choices (delay d vs. delay d’):

- delay                             d>0                  d’
- Reward                         R		       R’
**Hypothesis:**** ****fronto-parietal cortex.**
- delay 	       d=0                  d’
- Reward     R                      R’
**Hypothesis:**** ****fronto-parietal cortex**** ****and**** ****limbic****.**

- Time

- Time

## Methods

- Subjects given a series of choices between              ($R at d)  and  ($R' at d')  where R<R' and d<d'.

- d
- d'-d (R'-R)/R

-  { Today, 2 weeks, 1 month }
-  { 2 weeks, 1 month }
-  {1%, 3%, 5%, 10%, 15%, 25%, 35%, 50%}

## Q: Which regions only show elevated activation when a subject considers an immediate reward?

*x = -4mm*

- 0

- 7

- T13

- ventral
- striatum

- posterior
- cingulate
- cortex

- medial PFC

- medial
- OFC

- hippocampus

- medial
- OFC

- ventral striatum

- A: Limbic systems and para-limbic cortex.

##  Emotional brain

-  Emotional brain

## Analytic brain

## Brain Activity in the Frontal System and Limbic System Predict Behavior(Data for choices with an immediate option.)

- 0.0

- -0.05

- 0.05

- Choose
- Immediate
- Reward

- Choose
- Delayed
- Reward

**Limbic**
**System**

**Frontal****system**

- Brain Activity

- Brain Activity in the Frontal System and Limbic System Predict Behavior(Data for choices with an immediate option.)

## Conclusions of fMRI study

-  Time discounting results from the combined influence of two neural systems:
-  Limbic structures are impatient
-  Fronto-parietal systems are patient.
-  These two systems are separately implicated in ‘emotional’ and ‘analytic’ brain processes.
-  The limbic (emotional) brain, does not value delayed rewards
- The limbic brain creates a drive for instant gratification
- Results have now been replicated with juice rewards

## Summary

- A model of impulsivity
- Self-defeating behaviors
- Neuroimaging and neuroeconomics
- Future research:  Age variation
- Limbic drives
- Cortical control
- Learning and Memory
- Analytic cognition

## How quickly do different age groups learn how to exploit a complicated teaser rate offer? 

- How quickly do different age groups learn how to exploit a complicated teaser rate offer?

- Naives:
- Slow learners

- Sophisticates:
- Immediate learners

- 18-24

- 25-34

- 35-44

- 45-64

- 65+

- Age of
- credit card
- holder

- Source: Agarwal, Driscoll, Gabaix, and Laibson (2006)