Pension behavior and policy

Individuals benefit from smoothing consumption over time, a fact well illustrated in the domain of pension spending. But many potential benefits from consumption smoothing are lost in practice due to an overconsumption in the present and near-future compared to the far-future, which is known as “present bias”. Present bias’s impact on pensioner welfare could potentially be exacerbated by international trends toward greater pension freedoms. However, actual pension spending decisions can involve sudden transitions into bankruptcy, which are hard to reconcile even with behavioral hyperbolical discounting models that are traditionally used to explain present bias. We consider an intertemporal consumption problem from a time-consistent but bounded rationality perspective. In this limited foresight framework, an individual exponentially discounts utilities (at constant rate, r) for a finite amount of time (until S) but ignores utilities that occur beyond that (up to T). The consumption paths implied by this simple model involve sudden transitions into bankruptcy at time S, resembling observed patterns from an international dataset on pension spending. Furthermore, this perspective suggests that individuals could be helped to appropriately smooth consumption over time via policy interventions directed at extending their level of foresight.

Optimal saving and sustainable foreign debt

This paper develops and discusses an open-economy growth model in a modi!ed Arrow learning-by-doing framework, in which workers learn through experience on the job, thereby increasing their productivity. Applying optimal control to maximize the discounted stream of intertemporal consumption, the model yields domestic saving rates of 18-22 percent of GDP, which are feasible targets in developing and emerging market economies. Sustainable gross foreign debt is in the range of 39-50 percent of GDP. Saving, debt, and growth policies are suggested.

INCOME DISTRIBUTION BY AGE GROUP AND PRODUCTIVE BUBBLES

The aim of this paper is to study the role of the distribution of income by age group on the existence of speculative bubbles. A crucial question is whether this distribution may promote a bubble associated to a larger level of capital, that is a productive bubble. We address these issues in an overlapping generations model where agents live three periods and productive investment done in the first period of life is an illiquid investment whose return occurs in the following two periods. A bubble is a liquid speculative investment that facilitates intertemporal consumption smoothing. We show that the distribution of income by age group determines both the existence and the effect of bubbles on aggregate production. We also show that fiscal policy, by changing the distribution of income, may facilitate or prevent the existence of bubbles and may also modify the effect that bubbles have on aggregate production.

Pseudo-Wealth and Consumption Fluctuations

This paper provides an explanation for situations in which the fundamental state variables describing the economy do not change, but aggregate consumption experiences significant changes. We present a theory of pseudo-wealth—individuals’ perceived wealth that is derived from expectations of gains in bets arising from heterogeneous expectations. This wealth is divorced from society's real assets. The creation of a market for bets necessarily generates positive pseudo-wealth. Changes in the magnitude of differences of prior beliefs will lead to changes in expected wealth and hence to changes in consumption, implying instability in aggregate and individual consumption and ex-post intertemporal consumption misallocations. Moreover, ‘completing markets’ through the creation of a new market for bets can increase individual and aggregate risk. With a utilitarian social welfare function, completing markets leads to lower welfare ex-post, but the first theorem of welfare economics (evaluating each individual's well-being on the basis of her ex ante beliefs) still holds, raising unsettling questions for welfare analysis. We also show that if the planner uses beliefs that are consistent, then the betting equilibrium would be Pareto inferior.

Does Household Finance Matter? Small Financial Errors with Large Social Costs

Households with familiarity biases tilt their portfolios toward a few risky assets. The resulting mean-variance loss from portfolio underdiversification is equivalent to only a modest reduction of about 1 percent per year in a household’s portfolio return. However, once we consider also the effect of familiarity biases on the asset- allocation and intertemporal consumption-savings decisions, the welfare loss is multiplied by a factor of four. In general equilibrium, the suboptimal decisions of households distort also aggregate growth, amplifying further the overall social welfare loss. Our findings demonstrate that financial markets are not a mere sideshow to the real economy and that improving the financial decisions of households can lead to large benefits, not just for individual households, but also for society. (JEL D14, D91, E21, E44, G11, G41)

Do Time Preferences Matter in Intertemporal Consumption and Portfolio Decisions?

We study the intertemporal consumption and portfolio rules in the model with the general hyperbolic absolute risk aversion (HARA) utility. The equivalent approximation approach is employed to obtain the Hamilton-Jacobi-Bellman (HJB) equations, and a remarkable property is shown: portfolio rules are independent of the discount function. Moreover, both the consumption and portfolio rates are non-increasing functions of wealth. Particularly illustrative cases examined in detail are the models with the most adopted discount functions, including exponential discounting and hyperbolic discounting. Explicit solutions for intertemporal decisions are found for these special cases, revealing that individual’s time preferences affect the consumption rules only. Moreover, the time-consistent consumption rate under hyperbolic discounting is larger than its counterpart under exponential discounting.

Dynamic Quantile Models of Rational Behavior

This paper develops a dynamic model of rational behavior under uncertainty, in which the agent maximizes the stream of future τ‐quantile utilities, for τ ∈ (0,1). That is, the agent has a quantile utility preference instead of the standard expected utility. Quantile preferences have useful advantages, including the ability to capture heterogeneity and allowing the separation between risk aversion and elasticity of intertemporal substitution. Although quantiles do not share some of the helpful properties of expectations, such as linearity and the law of iterated expectations, we are able to establish all the standard results in dynamic models. Namely, we show that the quantile preferences are dynamically consistent, the corresponding dynamic problem yields a value function, via a fixed point argument, this value function is concave and differentiable, and the principle of optimality holds. Additionally, we derive the corresponding Euler equation, which is well suited for using well‐known quantile regression methods for estimating and testing the economic model. In this way, the parameters of the model can be interpreted as structural objects. Therefore, the proposed methods provide microeconomic foundations for quantile regression methods. To illustrate the developments, we construct an intertemporal consumption model and estimate the discount factor and elasticity of intertemporal substitution parameters across the quantiles. The results provide evidence of heterogeneity in these parameters.

Intertemporal consumption behaviour in OIC countries

Purpose This study aims to examine the consumption behaviour in Organization of Islamic Cooperation countries. Design/methodology/approach Using time series and panel data, this study estimates rational expectations permanent income hypothesis model and the intertemporal elasticity of substitution, and examines the response in consumption to expected and unexpected changes in income. Findings The evidence supports the phenomenon of loss aversion. The response of consumption to unexpected income changes is statistically significant in only one-third of the countries in the sample. Conversely, the response of consumption to expected income changes is statistically as well as economically significant in one-fourth of the countries in the sample. The intertemporal elasticity of substitution is also statistically insignificant in majority of OIC countries in the sample. Practical implications The evidence in support of loss aversion in preferences could help in explaining the low penetration of equity-based risk sharing instruments in Islamic finance. Social implications The excess sensitivity of consumption to income suggests that redistribution efforts to enhance incomes of poor households could help in enhancing their consumption levels. Originality/value The study takes a comprehensive sample across time and space for OIC countries as compared to previous studies and also adjusts the budget constraint for Zakat.