Household Financial Decisions and Social Security

Princeton University, Princeton NJ

Investigators

Abstract

[unreadable] DESCRIPTION (provided by applicant): The purpose of the proposal is to study how a household's ability to make financial decisions affects its accumulation of assets for retirement and to consider the effects of reforms to the Social Security system given limited and heterogeneous household financial decision making abilities. This work is motivated by recent results that show i) there is considerable heterogeneity in the financial decisions made by households and ii) small differences in rates of return on assets across households generate large differences asset holdings in standard models of saving behavior. The available evidence suggests the heterogeneity in household financial decisions is related to variations in the households' comprehension of financial concepts. The first phase in the proposed research will be to build a model of household saving behavior that incorporates limited and heterogeneous decision-making capacities. This model will be tested by simulating household saving decisions and comparing the results to the observed distribution of wealth across U.S. households. The second phase of the proposed research is to reconsider reforms to the Social Security program in light of the limits to-household decision-making abilities. Proposals to create private Social Security accounts would place a larger decision-making burden on individual households. Households with limited understanding of financial matters may struggle to prepare for retirement under such a system. At the same time, households may respond to such a reform by increasing the effort that they devote to financial decision making. In addition, financial intermediaries may respond to such a reform by changing the products that they offer to households or by changing the terms of those contracts already offered. The proposed research will explore all of these possible effects within the context of the model that will be built in the first phase of the research. The impact of the proposed research will be i) to contribute to the understanding of the determinants of a household's ability to prepare for retirement and ii) to provide an analysis of Social Security reform when households have limited ability to make financial decisions. [unreadable] [unreadable] [unreadable]