Pension Research Council: The Boettner Center: Working Paper Library: 2008 Series

Working Paper Library: 2008 Series

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The Dynamics of Lifecycle Investing in 401(k) Plans
Mitchell, Olivia S; Mottola, Gary R; Utkus, Stephen P; Yamaguchi, Takeshi
BWP2008-01
The introduction of lifecycle funds into 401(k) plans offers a rich environment in which to assess workers’ portfolio allocation decisions. Consistent with behavioral models, employer design decisions strongly influence lifecycle adoption behavior while fundamentally altering portfolio characteristics, both in the cross-section and longitudinally. Yet there are also elements of rational choice by new employees, as well as choice constrained by information costs among workers with low literacy characteristics. We conclude that recent legislation encouraging riskier 401(k) portfolios will modify investment patterns, with the rate of change varying according to whether behavioral or rational elements dominate in a given setting.

The More the Better? Characteristics and Efficiency of 401(k) Investment Menus
Tang, Ning
BWP2008-02
Few previous studies have explored whether defined contribution retirement saving plans offer sufficiently diversified investment menus, though it is likely that these menus significantly shape workers’ accumulations of retirement wealth. This paper assesses the efficiency and performance of 401(k) investment options offered by a large group of US employers. We show that the majority of plans is efficient compared to market benchmark indexes. Three performance measures underscore the fact that these plans tend to offer a sensible investment menu, when measured in terms of the menus’ mean-variance efficiency, diversification, and participant utility. The key factor contributing to plan efficiency and performance is the particular set of funds offered, rather than the total number of investment options provided. We conclude that, in 401(k) arena, “more” is not necessarily “better.”

Hidden Regret and Advantageous Selection in Insurance Markets
Huang, Rachel J; Muermann, Alexander; and Tzeng, Larry Y
BWP2008-03
We examine insurance markets in which there are two types of customers: those who regret suboptimal decisions and those who don't. In this setting, we characterize the equilibria under hidden information about the type of customers and hidden action. We show that both pooling and separating equilibria can exist. Furthermore, there exist separating equilibria that predict a positive correlation between the amount of insurance coverage and risk type, as in the standard economic models of adverse selection, but there also exist separating equilibria that predict a negative correlation between the amount of insurance coverage and risk type, i.e. advantageous selection. Since optimal choice of regretful customers depends on foregone alternatives, any equilibrium includes a contract which is not purchased.

For Better, for Worse: Intra-household Risk-sharing over the Business Cycle
Shore, Stephen
BWP2008-04

How do the financial benefits of marriage vary with macroeconomic conditions? One of the major benefits of marriage is the ability to dynamically coordinate labor supply decisions in response to shocks. When one spouse loses a job, the other can work more. This paper argues that dynamic coordination is countercyclical; the innovations to husbands' and wives' labor incomes are more positively correlated when the economy is growing rapidly. As a result, while individuals face substantially more idiosyncratic labor income risk in bad times than good, households do not. Improved intra-household coordination in bad times nearly or completely undoes for couples the increased riskiness that comes to individuals. Since panel datasets are typically too short to capture more than a few business cycles, I exploit variation in the cross-sectional covariance of husbands and wives incomes to infer the covariance of past innovations to their incomes. Couples who have been married through periods of greater economic expansion have more positively correlated labor incomes in the cross-section, after controlling for a time trend in assortative mating. This implies that the correlation of couples' labor incomes falls by roughly 20 percent (e.g., from 10 percent to -10 percent) from booms to busts.

Reforms to an Individual Account Pension System and their Effects on Work and Contribution Decisions: The Case of Chile
Viviana Velez-Grajales
BWP2008-05

This study evaluates the effect of Chile’s pension system rules and regulations on individuals’ contribution and working decisions. In 1980 Chile was the first country to switch from a pay-as-you-go system to a privatized system based on individual investment accounts; then it has since been a model for pension reforms in many other Latin American countries. The Chilean system has also been considered by U.S. policy makers as a possible prototype for reform. This paper develops and estimates a dynamic behavioral model of individual decision-making about formal or informal sector employment and about pension contributions, accounting for regulations that govern the timing and level of pension benefits. Model parameters are obtained by the method of simulated maximum likelihood applied to longitudinal data from a new household survey, the Social Protection Survey (2002 to 2004), and administrative data from the pension regulatory agency. The estimated model is used to simulate the impact on employment and contribution patterns of changing the system rules. Reducing the number of quarters required to obtain the Minimum Pension and increasing the size of that pension increases work in the formal sector and contributions in the informal sector.

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