This grant funds work by behavioral economists Erzo Luttmer from Dartmouth and Dmitry Taubinsky from University of California, Berkeley, who are analyzing how behavioral biases might explain the annuity puzzle—the observation that annuities, as a financial product, are not nearly so popular as economic theory and people’s stated preferences would predict them to be. Of the many possible explanations for the annuity puzzle, behavioral biases are not easy to study. Consumers who avoid annuitization might have privileged information and unobserved motivations (like making bequests, for example), or they may be systematically affected by behavioral biases that result in suboptimal choices. Teasing out what accounts for what is not just difficult, but also important for devising potential remedies.
Luttmer and Taubinsky have carefully designed a series of controlled experiments where real economic incentives are at stake, but where most other complications from the real world have been abstracted away, thus allowing them to isolate how subjects’ psychological attitudes toward time and risk affect decision-making. By identifying the role behavioral mechanisms play in such decisions, this research will generate new insights about the annuity puzzle in particular, and also about the behavioral welfare economics of risk taking, saving decisions, and insurance markets more generally.