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Currently, the favourite explanation of self-control
problems given by open-minded economists is the
occurrence of present bias (Delaney and Lades, 2015;
O’Donoghue and Rabin, 2015), which suggests that the
conventional assumption of time-consistent decisions
and exponential discounting of future values is wrong.
When considering trade-offs on two future moments,
present biased preferences denote stronger weight to
the earlier moment as it gets closer (see O’Donoghue
and Rabin, 1999, 2001), describing, in this sense, a
conflict between an individual’s short-run and long run
“selves”.
This was initially formalized in the classic quasi-
hyperbolic discounting model of Laibson (1997):
where β and δ represent discount factors (usually with
β,δ<1), being the former a measure of present bias
and the later a measure of impatience. In other words,
outcomes delayed by an additional time period have
their values multiplied by δ, obtaining then its time-
discounted value, and all non-immediate outcomes are
multiplied by β, generating a short-term desire – the
so-called present bias – and potentially a self-control
failure. Those familiarised with behavioural economics
would promptly recognize that this model follows the
ideas of dual process theories, which assume that
human decision making consists of two distinct systems,
well-described by Daniel Kahneman (2003) in his Nobel
Prize lecture.
Despite its rich descriptive power, the quasi-hyperbolic
discounting model does not fully explain why time-
inconsistent decisions and self-control failures arise,
requiring then further extensions. In order to better
describe the nature of present bias, Delaney and Lades
(2015) built on psychological insights that understand
self-control problems as intrapersonal conflicts between
temptations and the ability of self-control. Basically,
a failure occur when the temptation dominates an
individual’s capacity to resist (self-control). Formally,
they proposed the following microfoundation for the
present bias parameter:
ntrol failure. Those familiarised with behavioural economics would promptly
cognize that this model follows the ideas of dual process theories, which assume that
man decision making consists of two distinct systems, well-described by Daniel
ahneman (2003) in his Nobel Prize lecture.
espite its rich descriptive power, t e quasi-hyperbolic discounting model does not
lly explain why time-inconsistent decisions and self-con rol failures arise, requiring
en further ex nsions. I order o better describ the ature of present bias, Delaney
d Lades (2015) built on psychological insights that underst nd self-control problems
intrapersonal conflicts between temptations and the ability f se f-control. Basically,
failure occur when the temptation d m ates an individual’s capacity to resist (self
-
ntrol). Formally, they pro osed the following microfoundation for the present bias
rameter:
=
1 1+ (1− )
(2)
here
T
> 0 represents temptations’ level and 0 <
SC
<1 represents self-control ability.
his formalisation suggests that present bias is positively related to temptations and
gatively related to self-control, so an individual needs self-control only when tempted.
his development allows the differentiation between heterogeneous decision makers in
rms of their sophistication (
O’
Donoghue and Rabin, 1999). For instance, sophisticated
dividuals are conscious that temptations and self-control weaknesses are likely events
everyday life, and so is present bias, so they might engage in proactive commitments
avoid or mitigate the effect of future temptations. On the opposite level, completely
where T > 0 represent temptations’ level and 0 < SC
<1 represents self-control ability. This formalisa n
suggests that present bias is positively related to
temptations and negatively related to self-control, so an
individual needs self-control only when tempted.
This development allows the differentiation between
heterogeneous decision makers in terms of their
sophistication (O’Donoghue and Rabin, 1999). For
instance, sophisticated individuals are conscious
that temptations and self-control weaknesses are
likely events in everyday life, and so is present bias,
so they might engage in proactive commitments to
avoid or mitigate the effect of future temptations. On
the opposite level, completely naïve individuals are
unaware of their present bias and believe they will not
encounter any temptations in the future. This is in line
with empirical studies on personality and individual
differences showing that individuals high in trait
self-control are more likely to avoid temptation and
distraction, rather than simply resisting goal-inhibiting
impulses (Ent et al., 2015).
The concepts of present bias and sophistication within
the context of self-control have become decisive for
policymaking and regulation. For example, present
biased sophisticated savers may demand financial
products which prescribe penalties and liquidity
constraints, such as mutual funds and pension plans,
to help them to overcome self-control problems. Also,
these individuals may avoid credit card use in order to
mitigate the occurrence of consumption temptations
and abuse of credit use. Sophisticated investors may
follow investment strategies that are tied to specific
asset allocation rules or non-discretionary trading
systems to avoid overconfidence and the desire of
maintaining losing trades for longer periods than the
profitable ones – the so-called disposition effect. At
the same time, a benevolent financial regulator would
wish to protect naïve participants that lack financial
literacy or are simply unaware of the constant visceral
influences on financial decisions. The remainder of
this article covers some applications of the current
knowledge about self-control problems, their effects on
fina cial decision making and the suggestions of recent
emp ical studies.
1. Retir ent savings, self-awareness and commitment
mechanisms
Present bias leads people to save insufficiently for
r tirement: even when they wish to save more, they
fail to do so by procrastinating the decision to opt-
in a pension plan. It has also been suggested that
self-awareness regarding one’s biases might be a
stronger determinant of financial behaviour than their
direct effect itself. Theoretical predictions between
behavioural parameters and the role of sophistication
on retirement savings were exposed by Goda et al
(2015, p. 9). For instance, a sophisticated saver, aware of
1
Self-control is an important capacity that prevents people from acting on impulses
which has been identified as a critical human skill in both economics and psychology.
Economists often defined self-control as the ability to stick to prior plans and thus have
consistent intertemporal choices. In psychology, self-control is defined as the ability to
regulate one's behaviours, emotions, and thoughts. This article addresses recent
developments that are overcoming disciplinary boundaries in order to generate a more
coherent desc iption for the role f self-control o everyday inancial behaviour,
including the behaviour of the Chief Financial Officers. As they have to most important
financial role in the firms. We focus on applications closely related to policymaking and
financial regulation, such as: saving for retirement, indebtedness and investment
attitudes. The present discussion suggests that the trait of self-control might prevent
failures by avoiding rather than resisting t temptations.
First of all, t reader must be familiar with some key concepts often discu sed in the
self-control literature. Currently, the favourite explanation of self-control problems
given by open-minded economists is the occurrence of present bias (Delaney and Lades,
2015
; O’Donoghue and Rabin, 2015), which suggests that the conventional assumption
of time-consistent decisions and exponential discou ting of future values is wrong.
When considering trade-offs on two future moments, prese t biased prefere ces denote
stronger weight to the earlier moment as it gets closer (see
O’Donoghue and Rabin,
1999, 2001), describing, in this sense, a conflict between
an individual’s
short-run and
long run “selves”
.
This was initially formalized in the classic quasi-hyperbolic discounting model of
Laibson (1997):
( , … ,
) = ( ) + ∑ (
+
)
=1
(1)
where and represent discount factors (usually with ,
< 1
), being the former a
measure of present bias and the later a measure of impatience. In other words, outcomes
delayed by an additio al tim eriod have their values multiplied b , obtaining then
its time-discounted value, and all non-im ediate outcomes are multiplied by ,
generating a short-term desire
–
the so-called present bias
–
and potentially a self-