The Role of Time Preferences and Exponential-Growth Bias in Retirement Savings

NBER Working Paper No. 21482

Issued in August 2015

NBER Program(s):Economics of Aging, Public Economics



There is considerable variation in retirement savings within income, age, and educational categories. Using a broad sample of the U.S. population, we elicit time preference parameters from a quasi-hyperbolic discounting model, and perceptions of exponential growth. We find that present bias (PB), the tendency to value utility in the present over the future in a dynamically inconsistent way, and exponential-growth bias (EGB), the tendency to neglect compounding, are prevalent and distinct latent variables. PB, EGB, and the long-run discount factor are all highly significant in predicting retirement savings, even while controlling for measures of IQ and general financial literacy as well as a rich set of demographic controls. We find that lack of self-awareness of these biases has an additional independent negative impact on retirement savings. We assess potential threats to a causal interpretation of our results with a hypothetical choice experiment and several robustness exercises. Finally, we explore potential mechanisms for our findings. If the relationship we estimate is causal, our estimates suggest that eliminating PB and EGB would be associated with an increase in retirement savings of 12%, or as high as 70% using estimates that account for classical measurement error.

A non-technical summary of this paper is available in the 2016 number 1 issue of the NBER Bulletin on Aging and Health. You can sign up to receive the NBER Bulletin on Aging and Health by email.



Acknowledgments

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Document Object Identifier (DOI): 10.3386/w21482

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