Older Americans face the dilemma of complex financial and health decisions combined with a high incidence of cognitive decline with age. One of the important policy proposals for dealing with the effects of cognitive limitations on economic decision- making is to set up institutions, such as """"""""automatic 401(k)'s,"""""""" which default people in to """"""""good"""""""" choices. The difficulty with this approach is that knowing what a """"""""good choice"""""""" is for an individual depends crucially on knowing her preferences. In particular, for retirement saving and investment choices, it is crucial to know the values of three preference parameters: risk aversion, time preference and the elasticity of intertemporal substitution (EIS). Even if policy ignores individual differences and creates one version of the default, a """"""""good"""""""" choice for everyone in the group still depends on at least knowing the distribution of preferences in that group. This project will extend our understanding and further our identification of these preferences and how the expression of these preferences is affected by cognitive abilities.
The specific aims are to: (1) Understand at a high level of analytic detail inconsistencies in measures of risk aversion and begin to do so for time preferences and the elasticity of intertemporal substitution;(2) Gauge the extent to which cognitive limitations (as opposed to non-standard preferences) are responsible for inconsistencies in different measures of risk preferences, and also time preferences and the elasticity of intertemporal substitution;and (3) Develop methods to overcome the difficulties cognitive limitations create in measuring these preferences-in particular by eliciting """"""""reasoned preferences"""""""" rather than using """"""""untutored preferences,"""""""" and implement these methods on a large sample of adults in the prime years for retirement saving. The more general aim is to develop techniques for identifying """"""""reasoned preferences"""""""" for the even larger set of preferences that matter for difficult decisions that older Americans face, even beyond the retirement saving decision.
The appropriate financial or health decision for an individual often depends in part on the individual's preferences, such as willingness to take risks. This project will study how cognitive abilities interact with measures of preferences that are relevant for financial and health decision-making, and will develop improved measures of these preferences that can be used to help people make the decisions that are best for them.
