Costly Attention and Retirement Puzzles
35 Pages Posted: 30 Apr 2019 Last revised: 1 Oct 2019
Date Written: September 30, 2019
This paper presents evidence that incorporating costly attention, modelled with rational inattention, might solves three well-established puzzles in the retirement literature. The first puzzle is that, given incentives, the extent of bunching of labour market exits at legislated state pension ages (SPA) seems incompatible with rational expectations (e.g. Cribb, Emmerson, and Tetlow, 2016). Adding to the evidence for this puzzle, this paper includes an empirical analysis focusing on whether liquidity constraints can account for this bunching and find they cannot. The nature of this puzzle is clarified by exploring a life-cycle model with rational agents that does match aggregate profiles. This model succeeds in matching these aggregates only by overestimating the impact of the SPA on poorer individuals whilst underestimating its impact on wealthier people. The second puzzle is that people are often mistaken about their own pension provisions (e.g. Gustman and Steinmeier, 2001). Concerning this second puzzle, I incorporate rational inattention to the SPA into the aforementioned life-cycle model, thus allowing for mistaken beliefs. To the best of my knowledge, this paper is the first not only to incorporate rational inattention into a life-cycle model but also to assess a rationally inattentive model against non-experimental individual choice data. This facilitates another important contribution to the rational attention literature: discipling the cost of attention with subjective expectations data. Preliminary results indicate costly attention better matches the response of participation to the SPA across the wealth distribution, hence offering a resolution to the first puzzle. The third puzzle is that despite in some countries more than actuarially fair options to defer receipt of pension benefits, take up remains extremely low (e.g. Shoven and Slavov, 2014). A simple extension of the main model generates, by extending the source of uncertainty and including a claiming decision, an explanation of this last puzzle: the actuarial calculations implying deferral being preferable ignore the utility cost of paying attention to your pension which can be avoided by claiming. This paper researches these puzzles in the context of the ongoing reform to the UK female state pension age.
Keywords: Rational inattention, Labour supply, Retirement, Pension provision, Learning
JEL Classification: D14, D83, D91, E21, J26, H55
Suggested Citation: Suggested Citation