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Rules of thumb in life-cycle savings models

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Author Info
Rodepeter, Ralf (Sonderforschungsbereich 504)
Winter, Joachim () (Mannheim Research Institute for the Economics of Aging (MEA))

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Abstract

We analyze life-cycle savings decisions when households use simple heuristics, or rules of thumb, rather than solve the underlying intertemporal optimization problem. The decision rules we explore are a simple Keynesian rule where consumption follows income; a simple consumption rule where only a fraction of positive income shocks is saved; a rule that corresponds to the permanent income hypothesis; and two rules that have been found in experimental studies. Using these rules, we simulate life-cycle savings decisions numerically and compute the utility losses relative to the backwards solution of the intertemporal optimization problem. Our central finding is that the utility losses induced by rule-of-thumb behavior are relatively low. We conclude that behaving optimally, in the sense of solving an intertemporal optimization model, is not only costly, it is also not much better than using simple heuristics. Our results might also explain why optimization models typically fit the main features of empirical data quite well although optimizing behavior itself is frequently rejected.

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Paper provided by Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim in its series Sonderforschungsbereich 504 Publications with number 99-81.

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Length: 30 pages
Date of creation: 01 Oct 1999
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Handle: RePEc:xrs:sfbmaa:99-81

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Essig, Lothar, 2004. "Methodological aspects of the SAVE data set," Sonderforschungsbereich 504 Publications 05-17, Sonderforschungsbereich 504, Universität Mannheim & Sonderforschungsbereich 504, University of Mannheim. [Downloadable!]
  2. Florian Heiss & Alexander Ludwig & Joachim Winter, 2002. "Pension reform, capital markets, and the rate of return," MEA discussion paper series 02023, Mannheim Research Institute for the Economics of Aging (MEA), University of Mannheim. [Downloadable!]
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  3. Lothar Essig, 2005. "Methodological aspects of the SAVE data set," MEA discussion paper series 05080, Mannheim Research Institute for the Economics of Aging (MEA), University of Mannheim. [Downloadable!]
  4. Jim Malley & Hassan Molana, 2002. "The Life-Cycle-Permanent-Income Model: A Reinterpretation and Supporting Evidence," Working Papers 2002_17, Department of Economics, University of Glasgow. [Downloadable!]
  5. Lothar Essig, 2005. "Methodological aspects of the SAVE data set," MEA discussion paper series 05080, Mannheim Research Institute for the Economics of Aging (MEA), University of Mannheim. [Downloadable!]
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