June 15, 2007 More than half of the participants in experiments conducted at the University of York fail to plan ahead when making dynamic decisions about their lives, according to the findings of research funded by the Economic and Social Research Council that will have implications for policies on financial planning and pensions.
Researchers ran a series of experiments to examine the approach that people took when faced with a sequence of choices.
They find that, contrary to economic theory, the participants often do not plan ahead when formulating a plan of action. The findings may have implications for public policy on long-term financial planning.
In a series of studies, the research shows that when faced with a decision-making process designed to test whether they plan ahead, more than half those taking part fail to think ahead.
One experiment included two decision points, each of which gave two options. It was designed so decision makers who planned ahead achieved the best outcome, while those that did not took a route that only appeared to be most favourable. Only 36 per cent took the optimal decision at the first node, while almost all (97 per cent) did at the second node.
"The experimental results are stark," says Professor John Hey of the University of York's Department of Economics and Related Studies, who led the research. "More than half the participants in the experiment had behaviour which implied that they do not plan ahead."
They then repeated the experiment but with pairs of subjects so that the first made the choice at the first decision point and the second at the second point. They went through the experiment four times so the first in the pair could see what the second was doing.
Again while decisions at the second node were almost always taken optimally, there was a similar pattern at the first decision point despite the fact there were two players. Less than 20 per cent took the correct decision on the first attempt, 35 per cent in the second, 35 per cent on the third and 35 per cent on the fourth.
Despite repeatedly seeing the decision taken by the second in the pair, the first of the pair took the wrong decision well over half the time. The implication is that more than half of the first players were not thinking ahead to what the second player was going to do.
Extending the research to three decision points to distinguish between those who plan completely ahead, those who plan one step ahead and those fail to plan at all, researchers found people fell into two extremes -- they either plan fully or not at all.
The researchers then ran an experiment to test the life-cycle model of consumption that says people should plan their spending through the end-point. They gave subjects a fixed amount of tokens and then allowed them to earn interest on them or convert some of them into cash at the end of each period.
While economic theory applied to that particular decision problem implies that people should convert a constant proportion of tokens into cash over time, the research showed that many subjects converted nothing for several periods and only then began to convert tokens into money at a constant rate.
Working with LUISS University in Rome, the researchers have developed a hypothesis that the trade-off between saving to earn interest and converting to earn money is not something that people do continuously and simultaneously but rather independently and sequentially.
Researchers carried out eight sets of experiments to test whether people or do not plan. One set was set in a very simple 2+2 tree setting (2 decision nodes interleaved with 2 chance nodes). Researchers extended this design to a 3+3 tree (3 decision nodes interleaved with 3 chance nodes) with an extended property: one route through the tree is best for someone who plans two periods ahead, another for those who plan only one period ahead and a third for those who do not plan ahead at all.
The ESRC-funded research is entitled 'Investigation of dynamic economic behaviour under risk and uncertainty'. ESRC reference number RES-000-27-0077.
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