Temptation and Retirement Accounts: A Story of Time Inconsistency and Bounded Rationality

• Main Authors: Florina Salaghe, Dimitra Papadovasilaki, Federico Guerrero, James Sundali
• Format: Article
• Language: English
• Published: Athens Institute for Education and Research 2020-07-01
• Series: Athens Journal of Business & Economics
• Subjects: absent-mindedness; asset allocations; imperfect recall; retirement saving; time inconsistency; temptation
• Online Access: https://www.athensjournals.gr/business/2020-6-3-1-Salaghe.pdf

Research shows that American workers tend to under-save for retirement. Some studies attribute the under-saving to a lack of self-control and time inconsistent saving plans, while others use the bounded rationality of retirement account holders as an alternative explanation. In this paper we ran a laboratory experiment using subjects residing in the U.S., to further explore the relationship between under-saving for retirement and investment decisions, in the context of an asset allocation game. A theoretical framework that can account for both time inconsistent (investment) behavior and boundedly rational (investment) choices is given by the “absent-minded driver’s (AMD) paradox” decision-making game of Piccione and Rubinstein (1997). The main idea of the AMD paradox is that (investment) plans that were optimal at the planning stage may no longer be optimal at decision time even if no new information and/or no change in preferences occurs. The contribution of this paper is twofold. First, our paper is the first to apply the AMD paradox to the study of asset allocation decisions in the laboratory. Second, we find that temptation and potentially boundedly rational choices seem to affect a significant number of subjects by inducing them to abandon their optimal investment plans in favor of luring potential returns offered by riskier assets