Fedor Iskhakov

Individual Capability and Effort in Retirement Benefit Choice

We investigate the role of capability and effort in the management of retirement ruin. In an experimental setting, we analyze how 854 DC plan members reallocated wealth between a lifetime annuity and a phased withdrawal account when we increased the risk of exhausting the phased withdrawal account before the end of life. We find that more numerate individuals who put effort into understanding product features chose more longevity insurance at higher ruin risks. Financially literate members were more likely to show understanding of the product features, but general financial literacy did not directly improve ruin risk management. Initiatives aiming to help DC members understand income stream products at the time of the decision are warranted.

Comment on “Constrained Optimization Approaches to Estimation of Structural Models”

We revisit the comparison of mathematical programming with equilibrium constraints (MPEC) and nested fixed point (NFXP) algorithms for estimating structural dynamic models by Su and Judd (2012). Their implementation of the nested fixed point algorithm used successive approximations to solve the inner fixed point problem (NFXP‐SA). We redo their comparison using the more efficient version of NFXP proposed by Rust (1987), which combines successive approximations and Newton–Kantorovich iterations to solve the fixed point problem (NFXP‐NK). We show that MPEC and NFXP are similar in speed and numerical performance when the more efficient NFXP‐NK variant is used.

The Dynamics of Bertrand Price Competition with Cost-Reducing Investments

We present a dynamic extension of the classic static model of Bertrand price competition that allows competing duopolists to undertake cost-reducing investments in an attempt to “leapfrog�? their rival to attain low-cost leadership – at least temporarily. We show that leapfrogging occurs in equilibrium, resolving the Bertrand investment paradox., i.e. leapfrogging explains why firms have an ex ante incentive to undertake cost-reducing investments even though they realize that simultaneous investments to acquire the state of the art production technology would result in Bertrand price competition in the product market that drives their ex post profits to zero. Our analysis provides a new interpretation of “price wars�?. Instead of constituting a punishment for a breakdown of tacit collusion, price wars are fully competitive outcomes that occur when one firm leapfrogs its rival to become the new low cost leader. We show that the equilibrium involves investment preemption only when the firms invest in a deterministically alternating fashion and technological progress is deterministic. We prove that when technological progress is deterministic and firms move in an alternating fashion, the game has a unique Markov perfect equilibrium. When technological progress is stochastic or if firms move simultaneously, equilibria are generally not unique. Unlike the static Bertrand model, the equilibria of the dynamic Bertrand model are generally inefficient. Instead of having too little investment in equilibrium, we show that duopoly investments generally exceed the socially optimum level. Yet, we show that when investment decisions are simultaneous there is a “monopoly�? equilibrium when one firm makes all the investments, and this equilibrium is efficient. However, efficient non-monopoly equilibria also exist, demonstrating that it is possible for firms to achieve efficient dynamic coordination in their investments while their customers also benefit from technological progress in the form of lower prices.

Default and naive diversification heuristics in annuity choice

Focuses on choices of life annuities by separating consumers’ preferences from their use of default options and the 1/n heuristic in an online allocation task experiment. Abstract Choices of retirement income stream products pose the usual challenges associated with credence goods. Moreover, high perceived (and actual) risk, irreversibility of most purchases , high expenditure , little opportunity for social learning and distant consequences make these choices even more intimidating to consumers. Nevertheless, governments worldwide have started to shift more responsibility for these choices to ordinary individuals , leading to decisions often driven by suboptimal heuri stics instead of careful evaluation of alternatives. This paper focuses on choices of life annuities by separating consumers’ preferences from their use of default options and the 1/n heuristic in an online allocation task experiment. We use a finite mixture model to show the extent to which specific consumer groups follow simplified choice heuristics , and profile members of the groups. Our results have important implications for public policy and marketing related to annuities, but also more generally for understanding the impact of heuristics in choices of credence goods like financial products and health care.Retirement income stream products are difficult for consumers to choose because of their high perceived risk, irreversibility, high expenditure, little opportunity for social learning and distant consequences. Prior literature is unclear about consumers’ use of heuristics in decumulation decisions or whether sociodemographics can help identify vulnerable consumers. In the context of Australia’s retirement income arrangements, we examine choices of life annuities and phased withdrawal products, and identify use of default options and the diversification (1/ n or 50:50) heuristic using a novel finite mixture modelling approach. The innovative feature of this approach is that it captures the very specific allocation pattern associated with choices based on deterministic decision rules, namely pronounced spikes at the locations of the particular heuristics with little mass in their surroundings. We show that more than 30% of decumulation choices rely on these two heuristics, and that cognitive and product knowledge limitations contribute to using such heuristics. The results have implications for public policy on decumulation of retirement savings, regulation of product disclosures and providers of annuity and phased withdrawal products. More generally, our model has the potential to provide better understanding of the use of heuristics in consumer decisions.

First Impressions Matter: An Experimental Investigation of Online Financial Advice

We explore how individuals assess the quality of financial advice they receive and how they form judgments about advisers. Using an incentivized discrete choice experiment, we show that first impressions matter: consumers more often follow advisers who dispense good advice before bad. We demonstrate how clients’ opinions of adviser quality can be manipulated by using an easily replicated confirmation strategy that depends on the quality of the advice and the difficulty and order of the advice topics. Our results also reveal how clients benefit from their own past experience and how they use professional credentials to guide their choices. Data, as supplemental material, are available at https://doi.org/10.1287/mnsc.2016.2590. This paper was accepted by John List, behavioral economics.

Individual Judgment and Trust Formation: An Experimental Investigation of Online Financial Advice

Using an online incentivized discrete choice experiment, we study how well individuals judge financial advice and whether factors other than advice quality influence their evaluations. We find evidence that some individuals rely on extraneous signals to judge advice quality and observe some persistency in adviser choice over time. Our results also explain how some advisers can maintain trustworthy reputations despite giving bad advice. Finally, we explore whether individuals learn throughout the experiment. Our findings have several public policy implications that are discussed in the conclusion.

The endogenous grid method for discrete‐continuous dynamic choice models with (or without) taste shocks

We present a fast and accurate computational method for solving and estimating a class of dynamic programming models with discrete and continuous choice variables. The solution method we develop for structural estimation extends the endogenous grid‐point method (EGM) to discrete‐continuous (DC) problems. Discrete choices can lead to kinks in the value functions and discontinuities in the optimal policy rules, greatly complicating the solution of the model. We show how these problems are ameliorated in the presence of additive choice‐specific independent and identically distributed extreme value taste shocks that are typically interpreted as “unobserved state variables” in structural econometric applications, or serve as “random noise” to smooth out kinks in the value functions in numerical applications. We present Monte Carlo experiments that demonstrate the reliability and efficiency of the DC‐EGM algorithm and the associated maximum likelihood estimator for structural estimation of a life‐cycle model of consumption with discrete retirement decisions. Life‐cycle model discrete and continuous choice Bellman equation Euler equation retirement choice endogenous grid‐point method nested fixed point algorithm extreme value taste shocks smoothed max function structural estimation C13 C63 D91

Constrained Optimization Approaches to Estimation of Structural Models: Comment

We revisit the comparison of mathematical programming with equilibrium constraints (MPEC) and nested fixed point (NFXP) algorithms for estimating structural dynamic models by Su and Judd (SJ, 2012). They used an inefficient version of the nested fixed point algorithm that relies on successive approximations. We re-do their comparison using the more efficient version of NFXP proposed by Rust (1987), which combines successive approximations and Newton-Kantorovich iterations to solve the fixed point problem (NFXP-NK). We show that MPEC and NFXP-NK are similar in performance when the sample size is relatively small. However, in problems with larger sample sizes, NFXP-NK outperforms MPEC by a significant margin.