Modelling Retirement Decisions with Incomplete Rationality - Insights for Policy Design

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Voluntary and mandatory pension savings have been lying at the core of the economics of aging for a long time. Demographic change and increased longevity reinforce the political relevance of this field is by putting financial strains on mandatory pay as you go schemes in both Poland and Germany. By increasing the importance of privately financed old-age provisions, governments have shifted the focus from the traditional defined benefit pension plans to defined contribution plans. Systems based on private savings such as defined contribution schemes, require individual workers recognition that maintaining living standards during retirement necessitates a substantial increase in contemporaneous savings. Both the financial risks entailed in many defined contribution plans and their partial voluntary nature are likely to generate significant heterogeneity in pension outcomes of defined contribution plans. The investment decisions finally made may not only depend on risk aversion and financial literacy, but also on personality traits that have traditionally been analyzed by psychologists, but have so far remained largely absent from pension system analyses. The objective of this project is to overcome the gaps in the literature using three approaches. First, we will empirically analyze the relationship between personality traits (Big Five, locus of control, risk aversion) and private saving and investment decisions using person-level survey data. Moreover, we plan to assess how different levels of financial literacy affect savings. Second, we will test the implicit assumption that the intertemporal allocation of consumption/savings is ruled by the same mechanism as the intratemporal allocation of consumption/leisure. Following the literature, we posit the transitivity property and test it empirically using data on the timing of retirement. Third, both these components will be nested in an overlapping generations (OLG) model with voluntary private savings and financial literacy, to analyze the interplay between the timing of retirement, overall savings and long-run macroeconomic stability. We posit that a tax incentivizing scheme can help to overcome the problem of insufficient private voluntary savings, thus enhancing welfare.