Household finance and libertarian paternalism

Transcription

1 Household finance and libertarian paternalism James J. Choi Yale Summer School in Behavioral Finance 2009 What determines consumption growth and asset allocations? The classic Euler equation u'( c 1) t+ 1 = Et β Rt+ 1 u'( ct ) With CRRA utility where γ is RRA, loglinearize to get EΔ ln c = 1 E R β + 1 γσ 2 ( ln ) 1 t t+ 1 t f, t+ 1 Δlnc t+ γ 2

2 What do households say? At one large U.S. food corporation 100% Assessment of own savings rate 80% 68% 60% 40% 31% 20% 0% 1% Too low About right Too high Choi, Laibson, Madrian, and Metrick (2002) The old routine when you joined a company with a 401(k) plan Welcome to the company Here is information on your 401(k) plan If you d like to join, call this toll free number or visit the benefits website

3 Automatic enrollment in the 401(k) Welcome to the company Here is information on your 401(k) plan If you don t do anything, you will be automatically enrolled at this contribution rate and asset allocation If you d like to opt out, call this toll free number or visit the benefits website Automatic enrollment effect Fraction enrolled in 401(k) 100% 80% 60% 40% 20% 0% Tenure (months) Hired and observed before automatic enrollment Hired under automatic enrollment (3% contribution default) Hired under automatic enrollment (6% contribution default) Beshears, Choi, Laibson, and Madrian (2008)

4 Defaults and herding Fraction of Participants % 3% 4 5% 6% 7 10% 11 15% Contribution Rate Hired before automatic enrollment Hired during automatic enrollment (3% default) Hired during automatic enrollment (6% default) Choi, Laibson, Madrian, and Metrick (2006) Defaults and herding Before Automatic Enrollment Money Market 7% Bonds 18% After Automatic Enrollment Money Market Default Fund Stocks 16% Bonds 3% Madrian and Shea (2001) 75% Stocks 81% Money Market

5 How sticky are defaults? 100% Fraction of participants 80% 60% 40% 20% 0% Tenure (months) Hired before AE: Default rate and fund Hired after AE: Default rate and fund Hired before AE: Default rate (3%) Hired after AE: Default rate (3%) Hired before AE: 100% in default fund Hired after AE: 100% in default fund Choi, Laibson, Madrian, and Metrick (2004) How sticky are defaults? Fraction of participants 80% 60% 40% 20% 0% Tenure (months) Hired before AE: Default rate and fund Hired after AE: Default rate and fund Hired before AE: Default rate (2%) Hired after AE: Default rate (2%) Hired before AE: 100% in default fund Hired after AE: 100% in default fund Choi, Laibson, Madrian, and Metrick (2004)

6 Is this a welfare-neutral change? 401(k) is an illiquid, tax advantaged savings vehicle This company matches contributions dollarfor dollar up to 6% of employee s salary Is this a welfare-neutral change? In national sample: Fraction agreeing with statement, You are glad your company offers automatic enrollment 98% of those who were automatically enrolled and didn t opt out 79% of those who opted out of automatic enrollment Harris Interactive, Retirement Made Simpler pdf.

7 Inertia: An application to corporate finance In a stock for stock merger 80% of individuals passively keep acquirer shares they receive 30% of institutions passively keep acquirer shares they receive Optimal corporate response if demand curve for its stock is downward sloping: Use stock for stock mergers instead of SEOs to raise equity capital Baker, Coval, and Stein (2007) Dynamic defaults: Save More Tomorrow 401(k) contribution rate rises automatically in the future Rise may coincide with pay raises Thaler and Benartzi (2004)

8 Contribution rate 16% 14% 12% 10% 8% 6% 4% 2% 0% Before Pay Pay Pay Pay raise 1 raise 2 raise 3 raise 4 Accepted advice to save more now Joined SMT Thaler and Benartzi (2004) SMT participation rate 100% 80% 60% 40% 20% 0% Q4 Q3 Q2 Q1 +Q1 +Q2 +Q3 +Q4 Time relative to auto enroll into SMT Benartzi, Peleg, and Thaler (2008)

9 Practical impact of defaults research Automatic enrollment in savings plans promoted by legislation Pension Protection Act of 2006 New Zealand Kiwisaver U.K. Pensions Act of 2008 Automatic enrollment adopted by 41% of 401(k) plans with >5,000 participants 31% of plans with 1,000 4,999 participants 31% of plans with participants Libertarian paternalism (Thaler and Sunstein, 2003) Nudging people to an outcome without restricting choice Helps irrational types Imposes minimal costs on rational types

10 Active decision Welcome to the company You have 30 days to tell us whether you want to be in the 401(k) plan Not stating a preference is not an option Carroll, Choi, Laibson, Madrian, and Metrick (2009) Active decision participation effect Fraction enrolled in 401(k) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Tenure at company (months) Active decision cohort Standard enrollment cohort Carroll, Choi, Laibson, Madrian, and Metrick (2009)

11 Active decision contribution rate effect Average 401(k) contribution rate (non participants included) 6% 5% 4% 3% 2% 1% 0% Tenure at company (months) Active decision cohort Standard enrollment cohort Carroll, Choi, Laibson, Madrian, and Metrick (2009) Contribution rate chosen under active decision Regression dependent variable If hired under active decision, contribution rate 3 months after hire If hired under standard enrollment, contribution rate 30 months after hire Carroll, Choi, Laibson, Madrian, and Metrick (2009)

12 Explanatory variables Female dummy Married dummy log(base pay) Age bucket dummies Active decision dummy Interactions between active decision dummy and demographic variables Carroll, Choi, Laibson, Madrian, and Metrick (2009) Contribution rate tobit (selected coefficients) Active decision cohort (0.247) Active decision cohort Female 1.989** (0.547) Active decision cohort Married (0.503) Active decision cohort Log(Base pay) (1.053) Active decision cohort (0 Age < 30) (3.553) Active decision cohort (30 Age < 40) (3.552) Active decision cohort (40 Age < 50) (3.578) Active decision cohort (50 Age < 60) (3.659) Carroll, Choi, Laibson, Madrian, and Metrick (2009)

13 A model of default and active decision effects 1. It is costly to opt out of a default 2. Opt out costs are time varying Creates option value for waiting 3. Actors may be procrastinators Carroll, Choi, Laibson, Madrian, and Metrick (2009) Hyperbolic discounting 1 Value of 1 util βδ βδ 2 βδ 3 Today Tomorrow 2 days from now Phelps and Pollack (1968), Laibson (1997) 3 days from now

14 Immediate cost of opting out: 6 Delayed benefit of opting out: 8 Short run discount factor β = 0.5 Long run discount factor δ = 1 Payoff from opting out today: = 2 Payoff from opting out tomorrow: ( 6 + 8) = 1 Model setup Infinite horizon Agent decides when to opt out of default s D and move to optimum s* s* is time invariant and treated as if known by agent Agent pays stochastic i.i.d. cost of opting out c Agent observes c before making her decision Until opt out, agent suffers flow loss L(s D, s*) 0 Agents have hyperbolic discount function For analytical tractability, we set δ = 1

15 Agent s solution Opt out if draw an action cost c < threshold c* Threshold increasing in flow loss L Threshold increasing in β Model prediction Active decision causes agents to immediately move to the savings rate they would have eventually chosen in a default regime Faster opt outs by those who move the furthest from the default upon opting out Opt out delay from a 0% contribution default Mean time to enrollment (days) Contribution rate chosen upon enrollment (% of salary) Carroll, Choi, Laibson, Madrian, and Metrick (2009)

16 Evaluating welfare under default policies Normative well being evaluated using exponential discounting, i.e. β = 1 One justification for this welfare criterion Suppose changes in the default policy are always implemented with a lag Then every incarnation of the agent would vote to use this welfare criterion Welfare loss function Total discounted loss β = 1 β = Initial flow loss L

17 Candidate optimal defaults Proposition 2 If β < 1, L = κ(s* d) 2, s* is uniformly distributed from s to s, then the optimal default is one of the following three types: 1. Center default (mean s*) 2. Offset default (to one side of the distribution) 3. Active decisions Carroll, Choi, Laibson, Madrian, and Metrick (2009) Optimal defaults as a function of s* heterogeneity and time inconsistency Proposition offset default s s 0.15 active decisions center default β Carroll, Choi, Laibson, Madrian, and Metrick (2009)

18 Classifying libertarian paternalistic interventions 1. Change default, d (Active decision is mathematically equivalent to an infinitely unappealing default that induces immediate action) 2. Change action cost, c 3. Change perceived optimum, s* Quick Enrollment: Making action cognitively easier Here is a pre selected contribution rate and asset allocation. Check this box and mail in this card if you d like to enroll at the pre selects.

19 Quick Enrollment effect Beshears, Choi, Laibson, and Madrian (2006) Gentle reminders 1,503 unenrolled employees at one company received survey 9% response rate Among survey questions: 1. How much are you actually saving for retirement? 2. How much should you ideally be saving for retirement? 3. When (if ever) are you planning on enrolling in your 401(k)? Carroll, Choi, Laibson, Madrian, and Metrick (2009)

20 401(k) enrollment in 4 months after survey 100% 80% 60% 40% 20% 0% 3.3% 3.7% Survey responders Survey non responders Carroll, Choi, Laibson, Madrian, and Metrick (2009) Norm salience U = (1 s)(x x 0 ) s(x x Norm ) where x is action taken x 0 is optimum in absence of norm x Norm is action prescribed by norm s is salience of norm Benjamin, Choi, and Strickland (2008)

21 Median reservation interest rate for delaying receipt of $4 for one week 14% 12% 10% 8.8% 8% 6% 4% 2% 2.2% 0% Asian identity not salient Asian identity salient Benjamin, Choi, and Strickland (2008) Targeted information provision Task Allocate $10,000 among four S&P 500 index funds Subject pool Wharton MBAs Harvard undergrads Harvard staff Choi, Laibson, and Madrian (2009)

22 Fees information treatment Mutual fund Symbol Front-end load Front-end load fee if you purchase $10,000 worth of shares Expense ratio Approximate annual ongoing fee if your average balance is $10,000 Allegiant S&P 500 Index Fund - Class A AEXAX 2.50% $ % $60 Morgan Stanley S&P 500 Index Fund - Class A SPIAX 5.25% $ % $64 Phoenix Insight Index Fund - Class A HIDAX 5.75% $ % $73 UBS S&P 500 Index Fund - Class A PSPIX 2.50% $ % $70 Choi, Laibson, and Madrian (2009) Mean fees paid $500 $400 $300 $200 $100 $456 $432 $255 $421 $431 $410 $366 $309 $309 $0 Staff MBAs College Control Fees info Min possible Choi, Laibson, and Madrian (2009)

23 How likely is it that you would change your decision if you consulted a professional investment advisor? Mean fee paid $600 $500 $400 $300 $200 $513$519 $456 $435 $453 $389 $409$424 $395 $100 $0 Staff MBAs College Not at all likely Somewhat likely Very likely Choi, Laibson, and Madrian (2009) Financial education seminars Curriculum Setting savings goals Asset allocation Managing credit and debt Insurance against financial risks

24 Employees not yet enrolled in 401(k) Attended seminar Didn t attend seminar 100% 14% 7% Planning to enroll Actually enrolling Actually enrolling Choi, Laibson, Madrian, and Metrick (2001) Employees already enrolled in 401(k) Attended seminar Didn t attend seminar 28% 8% 5% Planning to increase contribution rate Actually increased Actually increased Choi, Laibson, Madrian, and Metrick (2001)

25 Subsidizing good behaviors: 401(k) match Instantaneous, riskless return on 401(k) investment If you are over 59½ years old, can withdraw 401(k) money without penalty Lost arbitrage profits if match is unexploited Choi, Laibson, and Madrian (2007) 100% Fraction of >59½ employees with arbitrage losses 80% 60% 40% 20% 0% A B C D E F G Choi, Laibson, and Madrian (2007)

26 Average arbitrage loss (if loss > 0) $800 $600 $400 $200 $0 A B C D E F G Choi, Laibson, and Madrian (2007) References Baker, Malcom, Joshua Coval, and Jeremy C. Stein, Corporate Financing Decisions When Investors Take the Path of Least Resistance. Journal of Financial Economics. Benartzi, Shlomo, Ehud Peleg, and Richard H. Thaler, Choice Architecture and Retirement Saving Plans. UCLA mimeo. Benjamin, Daniel J., James J. Choi, and A. Joshua Strickland, Social Identity and Preferences. NBER Working Paper Beshears, John, James J. Choi, David Laibson, and Brigitte C. Madrian, The Importance of Default Options for Retirement Saving Outcomes: Evidence from the United States. In Lessons from Pension Reform in the Americas, Stephen J. Kay and Tapen Sinha, editors. Beshears, John, James J. Choi, David Laibson, and Brigitte C. Madrian, Simplification and Saving. NBER Working Paper Carroll, Gabriel D., Choi, James J., David Laibson, Brigitte C. Madrian, and Andrew Metrick, Optimal Defaults and Active Decisions. Quarterly Journal of Economics. Choi, James J., David Laibson, and Brigitte C. Madrian, $100 Bills on the Sidewalk: Suboptimal Investment in 401(k) Plans. NBER Working Paper

27 Choi, James J., David Laibson, and Brigitte C. Madrian, Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds. Review of Financial Studies, forthcoming. Choi, James J., David Laibson, Brigitte C. Madrian, and Andrew Metrick, Defined Contribution Pensions: Plan Rules, Participant Decisions, and the Path of Least Resistance. In Tax Policy and the Economy 16, James Poterba, editor. Choi, James J., David Laibson, Brigitte C. Madrian, and Andrew Metrick, For Better or For Worse: Default Effects and 401(k) Savings Behavior. In Perspectives in the Economics of Aging, David A. Wise, editor. Choi, James J., David Laibson, Brigitte C. Madrian, and Andrew Metrick, Saving for Retirement on the Path of Least Resistance. In Behavioral Public Finance: Toward a New Agenda, Ed McCaffrey and Joel Slemrod, editors. Laibson, David, Golden Eggs and Hyperbolic Discounting. Quarterly Journal of Economics. Madrian, Brigitte C., and Dennis Shea, The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior. Quarterly Journal of Economics. Phelps, Edmund S., and Robert A. Pollak, On Second Best National Savings and Game Equilibrium Growth. Review of Economic Studies. Sunstein, Cass R., and Richard H. Thaler, Libertarian Paternalism. American Economic Review. Thaler, Richard H., and Shlomo Benartzi, Save More Tomorrow: Using Behavioral Economics to Increase Employee Savings. Journal of Political Economy.