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The Age of Reason: Financial Decisions over the Life-Cycle with Implications for Regulation

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  • Laibson, David I.
  • Agarwal, Sumit
  • Driscoll, John C.
  • Gabaix, Xavier

Abstract

Many consumers make poor financial choices and older adults are particularly vulnerable to such errors. About half of the population between ages 80 and 89 either has dementia or a medical diagnosis of “cognitive impairment without dementia.†We study lifecycle patterns in financial mistakes using a proprietary database that measures ten different types of credit behavior. Financial mistakes include suboptimal use of credit card balance transfer offers, misestimation of the value of one’s house, and excess interest rate and fee payments. In a cross-section of prime borrowers, middle-aged adults make fewer financial mistakes than younger and older adults. We conclude that financial mistakes follow a U-shaped pattern, with the cost-minimizing performance occurring around age 53. We analyze regulatory regimes that may help individuals avoid making financial mistakes. Some of these regimes are designed to address the particular challenges faced by older adults, but much of our discussion is relevant for all vulnerable populations. We discuss disclosure, nudges, financial driving licenses, advanced directives, fiduciaries, asset safe harbors, ex-post and ex-ante regulatory oversight. Finally, we pose seven questions for future research on cognitive limitations and associated policy responses.

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File URL: http://dash.harvard.edu/bitstream/handle/1/4554335/Laibson_AgeofReason.pdf
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Bibliographic Info

Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 4554335.

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Date of creation: 2009
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Publication status: Published in Brookings Papers on Economic Activity
Handle: RePEc:hrv:faseco:4554335

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  1. John Beshears & James J. Choi & David Laibson & Brigitte C. Madrian, 2006. "Simplification and Saving," NBER Working Papers, National Bureau of Economic Research, Inc 12659, National Bureau of Economic Research, Inc.
  2. James J Choi & David Laibson & Brigitte C Madrian, 2008. "Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds," Levine's Working Paper Archive, David K. Levine 122247000000002014, David K. Levine.
  3. Lusardi, Annamaria & Mitchell, Olivia S., 2007. "Financial literacy and retirement preparedness: Evidence and implications for financial education programs," CFS Working Paper Series, Center for Financial Studies (CFS) 2007/15, Center for Financial Studies (CFS).
  4. Geng Li, 2009. "Information sharing and stock market participation: evidence from extended families," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2009-47, Board of Governors of the Federal Reserve System (U.S.).
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  6. Xavier Gabaix & David Laibson, 2005. "Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets," NBER Working Papers, National Bureau of Economic Research, Inc 11755, National Bureau of Economic Research, Inc.
  7. James J. Choi & David Laibson & Brigitte C. Madrian, 2005. "$100 Bills on the Sidewalk: Suboptimal Investment in 401(k) Plans," NBER Working Papers, National Bureau of Economic Research, Inc 11554, National Bureau of Economic Research, Inc.
  8. Ran Spiegler, 2006. "The Market for Quacks," Review of Economic Studies, Oxford University Press, Oxford University Press, vol. 73(4), pages 1113-1131.
  9. Sumit Agarwal & John C. Driscoll & Xavier Gabaix & David Laibson, 2008. "Learning in the Credit Card Market," NBER Working Papers, National Bureau of Economic Research, Inc 13822, National Bureau of Economic Research, Inc.
  10. Victor Stango & Jonathan Zinman, 2009. "Exponential Growth Bias and Household Finance," Journal of Finance, American Finance Association, American Finance Association, vol. 64(6), pages 2807-2849, December.
  11. John Helliwell & Haifang Huang, 2011. "Well-Being and Trust in the Workplace," Journal of Happiness Studies, Springer, Springer, vol. 12(5), pages 747-767, October.
  12. Xavier Gabaix & David Laibson & Guillermo Moloche & Stephen Weinberg, 2005. "Information Acquisition: Experimental Analysis of a Boundedly Rational Model," Levine's Bibliography, UCLA Department of Economics 666156000000000480, UCLA Department of Economics.
  13. Richard Thaler & Shlomo Benartzi, 2004. "Save more tomorrow: Using behavioral economics to increase employee saving," Natural Field Experiments, The Field Experiments Website 00337, The Field Experiments Website.
  14. Daniel J. Benjamin & Sebastian A. Brown & Jesse M. Shapiro, 2006. "Who is “Behavioral”? Cognitive Ability and Anomalous Preferences," Levine's Working Paper Archive, David K. Levine 122247000000001334, David K. Levine.
  15. Paul Heidhues & Botond Koszegi, 2010. "Exploiting Naivete about Self-Control in the Credit Market," American Economic Review, American Economic Association, American Economic Association, vol. 100(5), pages 2279-2303, December.
  16. Pablo Antolín & Colin Pugh & Fiona Stewart, 2008. "Forms of Benefit Payment at Retirement," OECD Working Papers on Insurance and Private Pensions, OECD Publishing 26, OECD Publishing.
  17. Bruce A. Weinberg & David W. Galenson, 2005. "Creative Careers: The Life Cycles of Nobel Laureates in Economics," NBER Working Papers, National Bureau of Economic Research, Inc 11799, National Bureau of Economic Research, Inc.
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Cited by:
  1. John Gathergood, . "Self-Control, Financial Literacy and Consumer Over-Indebtedness," Discussion Papers, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM) 12/02, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
  2. Zvi Bodie & J�r�me Detemple & Marcel Rindisbacher, 2009. "Life-Cycle Finance and the Design of Pension Plans," Annual Review of Financial Economics, Annual Reviews, Annual Reviews, vol. 1(1), pages 249-286, November.
  3. Graham, John R. & Harvey, Campbell R. & Puri, Manju, 2013. "Managerial attitudes and corporate actions," Journal of Financial Economics, Elsevier, Elsevier, vol. 109(1), pages 103-121.
  4. Joanne W. Hsu & Robert J. Willis, 2013. "Dementia risk and financial decision making by older households: the impact of information," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2013-45, Board of Governors of the Federal Reserve System (U.S.).
  5. Disney, Richard & Gathergood, John, 2013. "Financial literacy and consumer credit portfolios," Journal of Banking & Finance, Elsevier, Elsevier, vol. 37(7), pages 2246-2254.
  6. Hugh H. Kim & Raimond Maurer & Olivia S. Mitchell, 2013. "Time is Money: Life Cycle Rational Inertia and Delegation of Investment Management," NBER Working Papers, National Bureau of Economic Research, Inc 19732, National Bureau of Economic Research, Inc.
  7. Agarwal, Sumit & Hu, Luojia & Huang, Xing, 2013. "Rushing into American Dream? House Prices, Timing of Homeownership, and Adjustment of Consumer Credit," Working Paper Series, Federal Reserve Bank of Chicago WP-2013-13, Federal Reserve Bank of Chicago.
  8. Heiss, Florian & Leive, Adam & McFadden, Daniel & Winter, Joachim, 2012. "Plan selection in Medicare Part D: Evidence from administrative data," Annual Conference 2012 (Goettingen): New Approaches and Challenges for the Labor Market of the 21st Century, Verein für Socialpolitik / German Economic Association 65406, Verein für Socialpolitik / German Economic Association.
  9. Erner, Carsten & Klos, Alexander & Langer, Thomas, 2013. "Can prospect theory be used to predict an investor’s willingness to pay?," Journal of Banking & Finance, Elsevier, Elsevier, vol. 37(6), pages 1960-1973.
  10. John V. Duca & Anil Kumar, 2011. "Financial literacy and mortgage equity withdrawals," Working Papers, Federal Reserve Bank of Dallas 1110, Federal Reserve Bank of Dallas.
  11. Gábor Kézdi & Robert J. Willis, 2013. "Expectations, Aging and Cognitive Decline," NBER Chapters, National Bureau of Economic Research, Inc, in: Discoveries in the Economics of Aging, pages 305-337 National Bureau of Economic Research, Inc.
  12. Nofsinger, John R., 2012. "Household behavior and boom/bust cycles," Journal of Financial Stability, Elsevier, Elsevier, vol. 8(3), pages 161-173.
  13. Meta Brown & Wilbert van der Klaauw & Jaya Wen & Basit Zafar, 2013. "Financial education and the debt behavior of the young," Staff Reports, Federal Reserve Bank of New York 634, Federal Reserve Bank of New York.
  14. Klapper, Leora & Lusardi, Annamaria & Panos, Georgios A., 2013. "Financial literacy and its consequences: Evidence from Russia during the financial crisis," Journal of Banking & Finance, Elsevier, Elsevier, vol. 37(10), pages 3904-3923.

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