Economics Insights @ CBS

This study incorporates a recent preference specification of expectations-based loss aversion, which has been applied broadly in microeconomics, into a classic macro model to offer a unified explanation for three empirical observations about life-cycle consumption. First, loss aversion explains excess smoothness and sensitivity — that is, the empirical observation that consumption responds to income shocks with a lag. Intuitively, such lagged responses allow the agent to delay painful losses in consumption until his expectations have adjusted.

This paper proposes an institutional solution that can help unlock the flow of low yielding long-term savings towards high-return infrastructure investments. The solution is to transform public–private partnerships (PPPs) in infrastructure as well as the classic model of multilateral development banks. Instead of thinking of PPPs as bilateral contracts between a private concession operator and a government agency, we argue that they should be conceived as partnerships that also involve a development bank and long-term institutional investors as partners.

Principals often operate on misspecified models of their agents' preferences. When preferences are such that non-local incentive constraints may bind in the optimum, even slight misspecification of the preferences can lead to large and non-vanishing losses. Instead, we propose a two-step scheme whereby the principal: (1) identifies the model-optimal menu; and (2) modifies prices by offering to share with the agent a fixed proportion of the profit she would receive if an item were sold at the model-optimal price.

We examine the international equity allocations of over 3 million individuals in 296 401(k) plans over the 2006-2011 period. These allocations show enormous cross-individual variation, ranging between zero and over 75%, as well as an upward trend that is only partially accounted for by the slight decrease in importance of the US market relative to the world market. International equity allocations also display strong cohort effects, with younger cohorts investing more internationally than older ones, but also each cohort investing more internationally over time.