The Age of Reason: Financial Decisions over the Life-Cycle with Implications for Regulation

76 Pages Posted: 29 Mar 2008 Last revised: 22 Oct 2009

Sumit Agarwal

Georgetown University - Department of Finance

John C. Driscoll

Federal Reserve Board

Xavier Gabaix

Harvard University - Department of Economics; National Bureau of Economic Research (NBER); Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); New York University - Stern School of Business

David Laibson

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Multiple version iconThere are 3 versions of this paper

Date Written: October 19, 2009

Abstract

Many consumers make poor financial choices and older adults are particularly vulnerable to such errors. About half of the population between ages 80 and 89 either has dementia or a medical diagnosis of "cognitive impairment without dementia." We study lifecycle patterns in financial mistakes using a proprietary database that measures ten different types of credit behavior. Financial mistakes include suboptimal use of credit card balance transfer offers, misestimation of the value of one's house, and excess interest rate and fee payments. In a cross-section of prime borrowers, middle-aged adults make fewer financial mistakes than younger and older adults. We conclude that financial mistakes follow a U-shaped pattern, with the cost-minimizing performance occurring around age 53. We analyze regulatory regimes that may help individuals avoid making financial mistakes. Some of these regimes are designed to address the particular challenges faced by older adults, but much of our discussion is relevant for all vulnerable populations. We discuss disclosure, nudges, financial driving licenses, advanced directives, fiduciaries, asset safe harbors, ex-post and ex-ante regulatory oversight. Finally, we pose seven questions for future research on cognitive limitations and associated policy responses.

Keywords: Household finance, aging, financial sophistication, shrouding, credit cards, fees, mortgages, regulation

JEL Classification: D1, D4, D8, G2, J14

Suggested Citation

Agarwal, Sumit and Driscoll, John C. and Gabaix, Xavier and Laibson, David, The Age of Reason: Financial Decisions over the Life-Cycle with Implications for Regulation (October 19, 2009). Available at SSRN: https://ssrn.com/abstract=973790 or http://dx.doi.org/10.2139/ssrn.973790

Sumit Agarwal (Contact Author)

Georgetown University - Department of Finance ( email )

3700 O Street, NW
Washington, DC 20057
United States
202-687-8207 (Phone)

HOME PAGE: http://www.ushakrisna.com

John C. Driscoll

Federal Reserve Board ( email )

20th and C Streets, NW
Washington, DC 20551
United States

HOME PAGE: http://www.federalreserve.gov/econresdata/john-c-driscoll.htm

Xavier Gabaix

New York University - Stern School of Business ( email )

Stern School of Business
44 West 4th Street, Suite 9-190
New York, NY 10012-1126
United States

HOME PAGE: http://pages.stern.nyu.edu/~xgabaix/

Harvard University - Department of Economics ( email )

Littauer Center
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Centre for Economic Policy Research (CEPR)

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

David I. Laibson

Harvard University - Department of Economics ( email )

Littauer Center
Room M-14
Cambridge, MA 02138
United States
617-496-3402 (Phone)
617-495-8570 (Fax)

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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