Behavioral Economics and Aging David Laibson Harvard University and NBER July 8, 2009 RAND 1. Motivating Experiments A Thought Experiment Would you like to have A) 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) Choosing Today Eating Next Week Time If you were deciding today, would you choose fruit or chocolate for next week? Patient choices for the future: Choosing Today Eating Next Week Time Today, subjects typically choose fruit for next week. 74% choose fruit Impatient choices for today: Choosing and Eating Simultaneously Time If you were deciding today, would you choose fruit or chocolate for today? Time Inconsistent Preferences: Choosing and Eating Simultaneously Time 70% choose chocolate 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 Wednesday: 37% choose low brow. • Picking for second Wednesday: 29% choose low brow. Tonight I want to have fun… next week I want things that are good for me. Extremely thirsty subjects McClure, Ericson, Laibson, Loewenstein and Cohen (2007) • Choosing between, juice now or 2x juice in 5 minutes 60% of subjects choose first option. • Choosing between juice in 20 minutes or 2x juice in 25 minutes 30% of subjects choose first option. • We estimate that the 5-minute discount rate is 50% and the “long-run” discount rate is 0%. • Ramsey (1930s), Strotz (1950s), & Herrnstein (1960s) were the first to understand that discount rates are higher in the short run than in the long run. Outline 1. 2. 3. 4. 5. 6. 7. Motivating experimental evidence Theoretical framework Field evidence Neuroscience foundations Neuroimaging evidence Policy discussion The age of reason A copy of these slides will soon be available on my Harvard website. 2. Theoretical Framework • Classical functional form: exponential functions. D(t) = dt D(t) = 1, d, d2, d3, ... Ut = ut + d ut+1 + d2 ut+2 + d3 ut+3 + ... • But exponential function does not show instant gratification effect. • Discount function declines at a constant rate. • Discount function does not decline more quickly in the short-run than in the long-run. Discounted value of delayed reward Exponential Discount Function 1 Constant rate of decline 0 1 11 21 31 41 Week (time = t) -D'(t)/D(t) = rate of decline of a discount function Exponential Hyperbolic 51 Discount Functions Slow rate of decline in long run 1 Rapid rate of decline in short run 0 1 11 21 31 41 Week Exponential Hyperbolic 51 An exponential discounting paradox. Suppose people discount at least 1% between today and tomorrow. Suppose their discount functions were exponential. Then 100 utils in t years are worth 100*e(-0.01)*365*t utils today. • • • • What is 100 today worth today? What is 100 in a year worth today? What is 100 in two years worth today? What is 100 in three years worth today? 100.00 2.55 0.07 0.00 An Alternative Functional Form Quasi-hyperbolic discounting (Phelps and Pollak 1968, Laibson 1997) D(t) = 1, bd, bd2, bd3, ... Ut = ut + bdut+1 + bd2ut+2 + bd3ut+3 + ... Ut = ut + b [dut+1 + d2ut+2 + d3ut+3 + ...] b uniformly discounts all future periods. d exponentially discounts all future periods. For continuous time: see Barro (2001), Luttmer and Marriotti (2003), and Harris and Laibson (2009) Building intuition • To build intuition, assume that b = ½ and d = 1. • Discounted utility function becomes Ut = ut + ½ [ut+1 + ut+2 + ut+3 + ...] • Discounted utility from the perspective of time t+1. Ut+1 = ut+1 + ½ [ut+2 + ut+3 + ...] • Discount function reflects dynamic inconsistency: preferences held at date t do not agree with preferences held at date t+1. Application to massages b = ½ and d = 1 NPV in current minutes A 15 minutes now B 20 minutes in 1 hour 15 minutes now 10 minutes now C 15 minutes in 1 week D 20 minutes in 1 week plus 1 hour 7.5 minutes now 10 minutes now Application to massages b = ½ and d = 1 NPV in current minutes A 15 minutes now B 20 minutes in 1 hour 15 minutes now 10 minutes now C 15 minutes in 1 week D 20 minutes in 1 week plus 1 hour 7.5 minutes now 10 minutes now Exercise • Assume that b = ½ and d = 1. • Suppose exercise (current effort 6) generates delayed benefits (health improvement 8). • Will you exercise? • Exercise Today: • Exercise Tomorrow: -6 + ½ [8] = -2 0 + ½ [-6 + 8] = +1 • Agent would like to relax today and exercise tomorrow. • Agent won’t follow through without commitment. 3. Field Evidence Della Vigna and Malmendier (2004, 2006) • • • • Average cost of gym membership: $75 per month Average number of visits: 4 Average cost per vist: $19 Cost of “pay per visit”: $10 Choi, Laibson, Madrian, Metrick (2002) Self-reports about undersaving. Survey Mailed to 590 employees (random sample) Matched to administrative data on actual savings behavior Typical breakdown among 100 employees Out of every 100 surveyed employees 22 68 self-report saving too little 24 plan to raise savings rate in next 2 months 3 actually follow through Laibson, Repetto, and Tobacman (2007) Use MSM to estimate discounting parameters: – Substantial illiquid retirement wealth: W/Y = 3.9. – 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 – Consumption-income comovement: • Marginal Propensity to Consume = 0.23 (i.e. consumption tracks income) LRT Simulation Model • • • • • • • • Stochastic Income Lifecycle variation in labor supply (e.g. retirement) Social Security system Life-cycle variation in household dependents Bequests Illiquid asset Liquid asset Credit card debt • Numerical solution (backwards induction) of 90 period lifecycle problem. LRT Results: Ut = ut + b [dut+1 + d2ut+2 + d3ut+3 + ...] b = 0.70 (s.e. 0.11) d = 0.96 (s.e. 0.01) Null hypothesis of b = 1 rejected (t-stat of 3). Specification test accepted. Moments: %Visa: Visa/Y: MPC: f(W/Y): Empirical 68% 13% 23% 2.6 Simulated (Hyperbolic) 63% 17% 31% 2.7 Kaur, Kremer, and Mullainathan (2009): Compare two piece-rate contracts: Linear piece-rate contract (“Control contract”) 1. – 2. Earn w per unit produced Linear piece-rate contract with penalty if worker does not achieve production target T (“Commitment contract”) – Earn w for each unit produced if production>=T, earn w/2 for each unit produced if production<T Earnings Never earn more under commitment contract May earn much less T Production Kaur, Kremer, and Mullainathan (2009): • Demand for Commitment (non-paydays) – Commitment contract (Target>0) chosen 39% of the time – Workers are 11 percentage points more likely to choose commitment contract the evening before • Effect on Production (non-paydays) – Being offered contract choice increases average production by 5 percentage points relative to control – Implies 13 percentage point productivity increase for those that actually take up commitment contract – No effects on quality of output (accuracy) • Payday Effects (behavior on paydays) – Workers 21 percentage points more likely to choose commitment (Target>0) morning of payday – Production is 5 percentage points higher on paydays Some other field evidence • • • • • • • • • • • Ashraf and Karlan (2004): commitment savings Della Vigna and Paserman (2005): job search Duflo (2009): immunization Duflo, Kremer, Robinson (2009): commitment fertilizer Karlan and Zinman (2009): commitment to stop smoking Milkman et al (2008): video rentals return sequencing Oster and Scott-Morton (2005): magazine marketing/sales Sapienza and Zingales (2008,2009): procrastination Thornton (2005): HIV testing Trope & Fischbach (2000): commitment to medical adherence Wertenbroch (1998): individual packaging 4. Neuroscience Foundations • • • • • 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 burden/load is manipulated by having subjects keep a 2-digit or 7-digit number in mind as they walk from one room to another • On the way, subjects are given a choice between a piece of cake or a fruit-salad Processing burden % choosing cake Low (remember only 2 digits) 41% High (remember 7 digits) 63% Affective vs. Analytic Cognition Frontal cortex mPFC mOFC vmPFC Mesolimbic dopamine reward system Parietal cortex Relationship to quasi-hyperbolic model • Hypothesize that the fronto-parietal system is patient • Hypothesize that mesolimbic system is impatient. • Then integrated preferences are quasi-hyperbolic now t+1 t+2 t+3 PFC 1 1 1 1 … Mesolimbic 1 0 0 0 … Total 2 1 1 1 … Total normed 1 1/2 1/2 1/2 … Relationship to quasi-hyperbolic model • Hypothesize that the fronto-parietal system is patient • Hypothesize that mesolimbic system is impatient. • Then integrated preferences are quasi-hyperbolic Ut = ut + b [dut+1 + d2ut+2 + d3ut+3 + ...] (1/b)Ut = (1/b)ut + dut+1 + d2ut+2 + d3ut+3 + ... (1/b)Ut =(1/b-1)ut + [d0ut + d1ut+1 + d2ut+2 + d3ut+3 + ...] limbic fronto-parietal cortex Hypothesis: Limbic system discounts reward at a higher rate than does the prefrontal cortex. 1.0 discount value mesolimbic system prefrontal cortex 0.0 time 5. Neuroimaging Evidence McClure, Laibson, Loewenstein, and Cohen Science (2004) • Do agents think differently about immediate rewards and delayed rewards? • Does immediacy have a special emotional drive/reward component? • Does emotional (mesolimbic) brain discount delayed rewards more rapidly than the analytic (fronto-parietal cortex) brain? Choices involving Amazon gift certificates: Time delay Reward d>0 d’ R R’ Hypothesis: fronto-parietal cortex. Time delay d=0 d’ Reward R R’ Hypothesis: fronto-parietal cortex and limbic. McClure, Laibson, Loewenstein, and Cohen Science (2004) Emotional system responds only to immediate rewards 7 T13 0 Neural activity x = -4mm VStr y = 8mm MOFC z = -4mm MPFC PCC Seconds Earliest reward available today Earliest reward available in 2 weeks Earliest reward available in 1 month 0.4% 2s Analytic brain responds equally to all rewards VCtx PMA RPar DLPFC VLPFC LOFC x = 44mm 0.4% 2s x = 0mm 0 T13 15 Earliest reward available today Earliest reward available in 2 weeks Earliest reward available in 1 month Brain Activity Brain Activity in the Frontal System and Emotional System Predict Behavior (Data for choices with an immediate option.) 0.05 0.0 -0.05 Choose Smaller Immediate Reward Frontal system Emotional System Choose Larger Delayed Reward Conclusions of Amazon study • Time discounting results from the combined influence of two neural systems: • Mesolimbic dopamine system is impatient. • Fronto-parietal system is patient. • These two systems are separately implicated in ‘emotional’ and ‘analytic’ brain processes. • When subjects select delayed rewards over immediately available alternatives, analytic cortical areas show enhanced changes in activity. Open questions 1. What is now and what is later? • Our “immediate” option (Amazon gift certificate) did not generate immediate “consumption.” • Also, we did not control the time of consumption. 2. How does the limbic signal decay as rewards are delayed? 3. Would our results replicate with a different reward domain? 4. Would our results replicate over a different time horizon? New experiment on primary rewards: Juice McClure, Ericson, Laibson, Loewenstein, Cohen (Journal of Neuroscience, 2007) Subjects water deprived for 3hr prior to experiment (subject scheduled for 6:00) A 15s i ii 10s 5s Time … iii iv. Juice/Water squirt (1s ) B (i) Decision Period Free (10s max.) (ii) Choice Made 2s 15s Figure 1 (iii) Pause Variable Duration (iv) Reward Delivery Free (1.5s Max) Experiment Design d d'-d (R,R') { This minute, 10 minutes, 20 minutes } { 1 minute, 5 minutes } {(1ml, 2ml), (1ml, 3ml), (2ml, 3ml)} d = This minute d'-d = 5 minutes (R,R') = (2ml, 3ml) Comparison with Amazon experiment: Impatient areas (p<0.001) x = 0mm y = 8mm Patient areas (p<0.001) x = 0mm x = -48mm Juice only Figure 5 Impatient areas (p<0.01) x = -4mm y = 12mm Patient areas (p<0.01) x = 0mm Amazon only x = -48mm Both Measuring discount functions using neuroimaging data • Impatient voxels are in the emotional (mesolimbic) reward system • Patient voxels are in the analytic (prefrontal and parietal) cortex • Average (exponential) discount rate in the impatient regions is 4% per minute. • Average (exponential) discount rate in the patient regions is 1% per minute. 1.5 2 Average Beta Area Activation, Actual and Predicted (D=0,D'=1) 1 (D=0,D'=5) (D=10,D'=11) (D=10,D'=15) (D=20,D'=25) 0 .5 (D=20,D'=21) 0 5 10 15 Time to later reward Actual Predicted 20 25 1 1.5 2 Average Delta Area Activation, Actual and Predicted (D=0,D'=1) (D=10,D'=15) (D=0,D'=5) (D=10,D'=11) (D=20,D'=25) 0 .5 (D=20,D'=21) 0 5 10 15 Time to later reward Actual Predicted 20 25 Hare, Camerer, and Rangel (2009) Health Session 4s food item presentation Taste Session Rate Health + Decision Session Rate Taste Decide + + ?-?s fixation Rate Health Rate Taste Decide Rating Details • Taste and health ratings made on five point scale: -2,-1,0,1,2 • Decisions also reported on a five point scale: SN,N,0,Y,SY “strong no” to “strong yes” What is self-control? • Rejecting a good tasting food that is not healthy • Accepting a bad tasting food that is healthy More activity in DLPFC in trials with successful self control than in trials with unsuccessful self-control L p < .001 p < .005 Summary of neuroimaging evidence • One system associated with midbrain dopamine neurons (mesolimbic dopamine system) discounts at a high rate. • Second system associated with lateral prefrontal and posterior parietal cortex responsible for selfregulation (and shows relatively little discounting) • Combined function of these two systems accounts for decision making across choice domains, including non-exponential discounting regularities. Outline 1. 2. 3. 4. Experimental evidence for dynamic inconsistency. Theoretical framework: quasi-hyperbolic discounting. Field evidence: dynamic decisions. Neuroscience: – Mesolimbic Dopamine System (emotional, impatient) – Fronto-Parietal Cortex (analytic, patient) 5. Neuroimaging evidence – Study 1: Amazon gift certificates – Study 2: juice squirts – Study 3: choice of snack foods 6. Policy 6. Policy Defaults in the savings domain • 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 default fund • Call this phone number to opt out of enrollment or change your investment allocations Madrian and Shea (2001) Choi, Laibson, Madrian, Metrick (2004) 401(k) participation by tenure at firm 100% Automatic enrollment 80% 60% Standard enrollment 40% 20% 0% 0 6 12 18 24 30 36 Tenure at company (months) 42 48 Do people like a little paternalism? Survey given to workers who were subject to automatic enrollment: “You are glad your company offers automatic enrollment.” Agree? Disagree? • Enrolled employees: • Non-enrolled employees: • All employees: 98% agree 79% agree 97% agree Source: Harris Interactive Inc. The power of deadlines: Active decisions Carroll, 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 401(k) participation by tenure Fraction of employees ever participated 100% Active Decision Cohort 80% 60% Standard enrollment cohort 40% 20% 0% 0 6 12 18 24 30 36 42 Tenure at company (months) Active decision cohort 48 Standard enrollment cohort 54 Simplified enrollment raises participation Fraction Ever Participating in Plan Beshears, Choi, Laibson, Madrian (2006) 50% 2005 2004 40% 30% 2003 20% 10% 0% 0 3 6 9 12 15 18 21 24 27 30 33 Time since baseline (months) Extensions to health domain Use automaticity and deadlines to nudge people to make better health decisions One early example: Home delivery of chronic meds (e.g. maintenance drugs for diabetes and CVD) • Pharmaceutical adherence is about 50% • One problem: need to pick up your meds • Idea: use active decision intervention to encourage workers on chronic meds to consider home delivery • Early results: HD take up rises from 14% to 38% Cost saving at test company (preliminary estimates) Rxs at Mail (annualized) 350,000 300,000 Annualized Savings 250,000 200,000 50,000 $2,413,641 Members $1,872,263 Total Savings $4,285,904 Before SHD 150,000 100,000 Plan After SHD 0 Now need to measure effects on health. 81 Policy Debates • Pension Protection Act (2006) • Federal Thrift Savings Plan adopts autoenrollment (2009) • Auto-IRA mandate (2009?) • Consumer Financial Protection Agency (2009?) – Default/privileged plain vanilla financial products – Disclosure – Simplicity – Transparency – Education $100 bills on the sidewalk Choi, Laibson, Madrian (2004) • Employer 401(k) match is an instantaneous, riskless return • Particularly appealing if you are over 59½ years old – Can withdraw money from 401(k) without penalty • On average, half of employees over 59½ years old are not fully exploiting their employer match • Educational intervention has no effect Education and Disclosure Choi, Laibson, Madrian (2007) • Experimental study with 400 subjects • Subjects are Harvard staff members • Subjects read prospectuses of four S&P 500 index funds • Subjects allocate $10,000 across the four index funds • Subjects get to keep their gains net of fees 84 Data from Harvard Staff $581 $516 Control Treatment $518 $451 $385 $320 $255 85 3% of Harvard staff in Control Treatment put all $$$ in low-cost fund Fees salient $494 Fees from random allocation $431 Data from Harvard Staff $581 $516 Control Treatment $518 $451 Fees salient $494 $385 $320 $255 86 3% of Harvard staff in Control Treatment put all $$$ in low-cost fund 9% of Harvard staff in Fee Treatment put all $$$ in low-cost fund Fees from random allocation $431 7. The Age of Reason Agarwal, Driscoll, Gabaix, Laibson (2008) (1,2) Home Equity Loans and Home Equity Credit Lines • Proprietary data from large financial institutions • 75,000 contracts for home equity loans and lines of credit, from March-December 2002 (all prime borrowers) • We observe: – Contract terms: APR and loan amount – Borrower demographic information: age, employment status, years on the job, home tenure, home state location – Borrower financial information: income, debt-to-income ratio – Borrower risk characteristics: FICO (credit) score, loan-tovalue (LTV) ratio Home Equity Regressions • We regress APRs for home equity loans and credit lines on: – Risk controls: FICO score and Loan to Value (LTV) – Financial controls: Income and debt-to-income ratio – Demographic controls: state dummies, home tenure, employment status – Age spline: piecewise linear function of borrower age with knots at age 30, 40, 50, 60 and 70. • Next slide plots fitted values on age splines Home Equity Loan APR by Borrower Age 6.50 6.00 5.75 5.50 5.25 Borrower Age (Years) 80 77 74 71 68 65 62 59 56 53 50 47 44 41 38 35 32 29 26 23 5.00 20 APR (Percent) 6.25 Home Equity Credit Line APR by Borrower Age 5.50 5.00 4.75 4.50 4.25 Borrower Age (Years) 80 77 74 71 68 65 62 59 56 53 50 47 44 41 38 35 32 29 26 23 4.00 20 APR (Percent) 5.25 (3) “Eureka”: Learning to Avoid Interest Charges on Balance Transfer Offers • Balance transfer offers: borrowers pay lower APRs on balances transferred from other cards for a six-tonine-month period • New purchases on card have higher APRs • Payments go towards balance transferred first, then towards new purchases • Optimal strategy: make no new purchases on card to which balance has been transferred Eureka: Predictions • Borrowers may not initially understand / be informed about card terms • Borrowers may learn about terms by observing interest charges on purchases, or talking to friends – We should see “eureka” moments: new purchases on balance-transfer cards should drop to zero (in the month after borrowers “figure out” the card terms) • Study: 14,798 accounts which accepted such offers over the period January 2000 to December 2002 Propensity of Ever Experiencing a "Eureka" Moment by Borrower Age 90% 85% 80% 70% 65% 60% 55% 50% 45% Borrower Age (Years) 80 76 72 68 64 60 56 52 48 44 40 36 32 28 24 40% 20 Percent 75% Fraction of Borrowers in Each Age Group Experiencing a Eureka Moment, by Month Month One Month Three Month Five No Eureka Percent of Borrowers 60% 50% Month Two Month Four Month Six 40% 30% 20% 10% 0% 18 to 24 25 to 34 35 to 44 45 to 64 Borrower Age Category Over 65 Seven other examples • Three kinds of credit card fees: – Late payment – Over limit – Cash advance • • • • Credit card APRs Mortgage APRs Auto loan APRs Small business credit card APRs Frequency of Fee Payment by Borrower Age 0.33 0.31 0.29 0.27 0.25 Late Fee 0.23 Over Limit Fee 0.21 Cash Advance Fee 0.19 0.17 0.15 20 23 26 29 32 35 38 41 44 47 50 53 56 59 62 65 68 71 74 77 80 Fee Frequency (per month) 0.35 Borrower Age (Years) Auto Loan APR by Borrower Age 9.50 9.00 8.75 8.50 8.25 8.00 20 23 26 29 32 35 38 41 44 47 50 53 56 59 62 65 68 71 74 77 80 APR (Percent) 9.25 Borrower Age (Years) Credit Card APR by Borrower Age 18.50 18.00 17.75 17.50 17.25 17.00 20 23 26 29 32 35 38 41 44 47 50 53 56 59 62 65 68 71 74 77 80 APR (Percent) 18.25 Borrower Age (Years) Mortgage APR by Borrower Age 13.00 12.50 12.25 12.00 11.75 11.50 20 23 26 29 32 35 38 41 44 47 50 53 56 59 62 65 68 71 74 77 80 APR (Percent) 12.75 Borrower Age (Years) Small Business Credit Card APR by Borrower Age 16.00 15.50 15.25 15.00 14.75 14.50 20 23 26 29 32 35 38 41 44 47 50 53 56 59 62 65 68 71 74 77 80 APR (Percent) 15.75 Borrower Age (Years) U-shape for prices paid in 10 examples – – – – – – – – – – Home equity loans Home equity lines of credit Eureka moments for balance transfers Late payment fees Over credit limit fees Cash advance fees Auto loans Credit cards Small business credit cards Mortgages Salthouse Studies – Memory and Analytic Tasks 1.0 84 0.5 69 0.0 50 -0.5 31 -1.0 16 Word Recall (N = 2,230) Matrix Reasoning (N = 2,440) Spatial Relations (N = 1,618) Pattern Comparison (N = 6,547) -1.5 Percentile Z-Score 1.5 7 -2.0 20 30 40 50 60 70 80 90 Chronological Age Source: Salthouse (forth.) Dementia Ferri et al 2005 Prevalence of dementia: 60-64: 0.8% 65-69: 1.7% 70-74: 3.3% 75-79: 6.5% 80-84: 12.8% 85+: 30.1% Cognitive Impairment w/o Dementia (Plassman et al 2008) Prevalence: 71–79: 16.0% 80–89: 29.2% 90+: 39.0% Regulation? • Regulator creates a very broad safe harbor for financial services (e.g., caps on mutual fund fees, plain vanilla credit cards, mortgages without prepayment penalties, etc…). • An investor may conduct a financial transaction that is outside the safe harbor if the investor is advised by a fiduciary (with legal liability). Outline 1. 2. 3. 4. 5. 6. 7. Motivating experimental evidence Theoretical framework Field evidence Neuroscience foundations Neuroimaging evidence Policy applications The age of reason A copy of these slides will soon be available on my Harvard website.