Time Inconsistency and Financial Decision Making: Theory and Evidence

Inhaltsverzeichnis (Table of Contents)

• 1 Introduction
• 2 Theory of Dynamic Inconsistency
  • 2.1 Prerequisites
  • 2.2 The Multi-Selves Model
    • 2.2.1 Sophisticated Consumer
    • 2.2.2 Naïve Consumer
    • 2.2.3 Screening of Consumer Type
  • 2.3 Constrained Contracting: Two-part tariffs
  • 2.4 Partial Naïveté
  • 2.5 Application: Gym Attendance
  • 2.6 Political Implications and Welfare Analysis
• 3 Credit Card Market
  • 3.1 Introductory Remarks
  • 3.2 Behavioral Model of Credit Consumption
    • 3.2.1 General Setup and Assumptions
    • 3.2.2 Complete Information
    • 3.2.3 Incomplete Information
      • 3.2.3.1 Unknown B
      • 3.2.3.2 Unknown β and β
  • 3.3 Welfare Analysis
    • 3.3.1 Complete Information
    • 3.3.2 Incomplete Information
  • 3.4 Recent Legal and Empirical Developments
• 4 Retirement Savings
  • 4.1 Introductory Remarks
    • 4.1.1 Significance of Retirement Savings
    • 4.1.2 The 401(k) plan
  • 4.2 Behavioral Aspects of Retirement Savings Decisions
    • 4.2.1 Model
    • 4.2.2 Behavioral Phenomena
      • 4.2.2.1 Self-control
      • 4.2.2.2 Procrastination
    • 4.2.3 SMarT Plan
      • 4.2.3.1 Purpose of the plan
      • 4.2.3.2 Main Features
      • 4.2.3.3 Evidence
  • 4.3 Recent Developments
• 5 Summary and Conclusion

Zielsetzung und Themenschwerpunkte (Objectives and Key Themes)

This master's thesis aims to explore the implications of time inconsistency on financial decision-making, integrating theoretical models with empirical evidence. It examines how behavioral economics enhances our understanding of seemingly irrational choices in various financial contexts.

• Time inconsistency and its impact on individual choices.
• Behavioral models of credit card consumption and retirement savings.
• The limitations of the "homo economicus" model in predicting real-world behavior.
• Analysis of specific behavioral biases, such as loss aversion and procrastination.
• Evaluation of policy interventions aimed at mitigating the effects of time inconsistency.

Zusammenfassung der Kapitel (Chapter Summaries)

1 Introduction: This chapter introduces behavioral economics as a field that integrates psychological insights into economic modeling, contrasting it with the limitations of the neoclassical "homo economicus" model. It highlights the historical context, tracing the consideration of time-inconsistent preferences back to classical economists, while emphasizing the contributions of Tversky, Kahneman, and Thaler in establishing behavioral economics as a distinct field. The chapter uses the example of New York City taxi drivers' daily income targets to illustrate how behavioral biases, in this case loss aversion, can lead to decisions that deviate from neoclassical predictions of optimal behavior. This introduction sets the stage for the subsequent chapters by showcasing the importance of incorporating behavioral insights into economic modeling and prediction.

2 Theory of Dynamic Inconsistency: This chapter delves into the theoretical framework of dynamic inconsistency, outlining the prerequisites and exploring the multi-selves model, which distinguishes between sophisticated and naïve consumers. It examines the implications of different consumer types and explores mechanisms like constrained contracting and partial naïveté. The chapter uses the example of gym attendance to illustrate the practical implications of time inconsistency and its related welfare implications. The chapter provides a crucial theoretical foundation for understanding the behavioral patterns analyzed in later chapters, demonstrating how inconsistencies in preferences over time can lead to suboptimal outcomes.

3 Credit Card Market: This chapter applies the theoretical framework of dynamic inconsistency to the credit card market. It develops a behavioral model of credit consumption, analyzing scenarios with complete and incomplete information. This analysis includes different scenarios of information asymmetry regarding crucial parameters within the model. The chapter further incorporates a welfare analysis to examine the societal implications of credit card usage behavior, considering both complete and incomplete information contexts. Finally, it discusses recent legal and empirical developments in the credit card market, grounding the theoretical model within a real-world context.

4 Retirement Savings: This chapter focuses on the behavioral aspects of retirement savings decisions, examining how time inconsistency and other behavioral biases (like procrastination) impact individuals' saving behavior. It introduces the 401(k) plan as a significant example, analyzing its features and effectiveness in light of behavioral insights. The chapter then presents the SMarT plan as a potential solution to improve retirement savings outcomes by addressing specific behavioral challenges. The chapter concludes by reviewing recent developments in retirement savings policies and programs, connecting the behavioral insights explored earlier in the chapter to the practical implications of policy interventions.

Schlüsselwörter (Keywords)

Behavioral economics, time inconsistency, dynamic inconsistency, multi-selves model, credit card consumption, retirement savings, loss aversion, procrastination, 401(k) plan, SMarT plan, welfare analysis, incomplete information, homo economicus.

Frequently Asked Questions: Comprehensive Language Preview on Time Inconsistency and Financial Decision-Making

What is the main topic of this document?

This document is a comprehensive language preview of a master's thesis exploring the implications of time inconsistency on financial decision-making. It integrates theoretical models with empirical evidence, examining how behavioral economics enhances our understanding of seemingly irrational choices in various financial contexts, such as credit card consumption and retirement savings.

What are the key themes explored in this thesis?

The key themes include time inconsistency and its impact on individual choices; behavioral models of credit card consumption and retirement savings; the limitations of the "homo economicus" model; analysis of behavioral biases like loss aversion and procrastination; and evaluation of policy interventions to mitigate the effects of time inconsistency.

What theoretical framework is used?

The thesis utilizes the theoretical framework of dynamic inconsistency, including the multi-selves model differentiating between sophisticated and naïve consumers. It explores concepts like constrained contracting and partial naïveté to explain behavioral patterns.

Which financial contexts are analyzed?

The thesis analyzes the credit card market and retirement savings decisions. For credit cards, it develops a behavioral model considering complete and incomplete information scenarios. For retirement savings, it examines the 401(k) plan and introduces the SMarT plan as a potential solution to improve savings outcomes.

What behavioral biases are discussed?

The document discusses several behavioral biases, including loss aversion (illustrated by the NYC taxi driver example) and procrastination, which significantly influence financial decision-making, especially concerning retirement savings.

What is the "homo economicus" model, and why is it critiqued?

The "homo economicus" model is a neoclassical economic model assuming perfectly rational and consistent individuals. The thesis critiques this model for its limitations in predicting real-world behavior, highlighting the need for behavioral economics to incorporate psychological insights.

What policy interventions are considered?

The thesis evaluates policy interventions aimed at mitigating the negative effects of time inconsistency. The SMarT plan for retirement savings is discussed as one such example.

What is the structure of the thesis?

The thesis is structured into five chapters: an introduction to behavioral economics and time inconsistency; a detailed exploration of the theory of dynamic inconsistency; an application to the credit card market; an analysis of retirement savings; and a concluding summary.

What are the key chapters and their summaries?

Chapter 1 introduces behavioral economics; Chapter 2 details the theory of dynamic inconsistency; Chapter 3 applies the theory to the credit card market; Chapter 4 focuses on retirement savings, including the 401(k) and SMarT plans; and Chapter 5 provides a summary and conclusion. Detailed summaries of each chapter are included in the document.

What keywords describe the thesis?

Keywords include: Behavioral economics, time inconsistency, dynamic inconsistency, multi-selves model, credit card consumption, retirement savings, loss aversion, procrastination, 401(k) plan, SMarT plan, welfare analysis, incomplete information, homo economicus.