1

Youth and Inexperience: Dynamic Inconsistency Among Emerging Adults

______

A Thesis

Presented to

The Honors Tutorial College

Ohio University

______

In Partial Fulfillment of the Requirements for Graduation from the Honors Tutorial College with the degree of

Bachelor of Business Administration

______by

Brian J. Gibbons

April 2014

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Discovery of Topic

The process of developing the idea for this thesis took a considerable amount of time. The beginnings of my exploration for a topic took place in a class I took with

Dr. Paxton, my thesis advisor, which was entitled The Economics of Altruism. In this class and the accompanying tutorial, we explored the economic reasoning behind why someone might choose to make an altruistic decision rather than a selfish one. This was my introduction to behavioral economics, which I found to be a very interesting subject. During that first tutorial, I explored some of the economics literature concerning an individual’s behavior and the economic rationale behind the making choices and, more specifically, choices that would appear to be economically or behaviorally irrational.

From there, I came across the topic of time inconsistent behavior and hyperbolic discounting which, as I will explain in detail in the following paragraphs, is when a person reverses his or her preferences because of an inconsistent value they place on time. This preference reversal is specific in that the person is impatient with their preferences now but anticipates being more patient in the future. Hyperbolic discounting is one of the most prevalent models in the relatively new field of behavioral economics. Understanding the fundamental concept of hyperbolic discounting, as well as the functional form of the model and the accompanying literature, took almost an entire year of tutorial instruction. During the time I was learning about the hyperbolic discounting model, I was also considering what way I could build upon the literature and develop a topic for my thesis. 3

The initial idea I came up with was to run a study that identified hyperbolic discounters through a survey sent to Ohio University alumni. Using the results from that survey, I would try to point out which people displayed inconsistent preferences and tendencies towards donating money to Ohio University. Once I identified these people, I planned on marketing a commitment device to the sample that would allow an individual to start donating a small amount of money in the present that then escalated to a target amount of donation per period sometime in the future. An initial survey was sent out to over 50,000 alumni through e-mail. From this survey, I gathered over 1,300 responses.

After spending a few months analyzing and cleaning the data, I found that although preferences towards giving was an interesting topic, there was a much stronger story that related hyperbolic discounting tendencies to age. I began reading into the literature surrounding the intertemporal (choices between payoffs at different periods in time) and behavioral characteristics of young adults and members of different generations. What I found was that although there was much written about the various characteristics of emerging adults and members of Gen Y, there was nothing written relating their distinct characteristics to their intertemporal preferences.

Given that I had found a distinct difference between the intertemporal preferences of adults age 21-30 and adults over 30, I felt I had a solid framework to begin my academic article which I later titled, “Youth and Inexperience: Dynamic Inconsistency

Among Emerging Adults.”

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Explanation of Time Inconsistency

The basis of the topic I explored for my thesis was time inconsistency. Time inconsistency, in very simple terms, can be explained as when an individual prefers a specific future outcome in the present, but then reverses his or her preference towards that outcome and favors a different outcome when the future period becomes the present. These potential outcomes could involve anything ranging from an individual’s time, money, health, or even happiness or satisfaction. People who are time inconsistent are often unable to judge exactly how little value they are placing on the future, so when the future becomes the present they change their mind on plans they had previously made. Therefore they experience a preference reversal on an intertemporal choice.

For instance, imagine someone who is out of shape that one day decides that they would like to improve their physical fitness. This person likely already has a set of commitments that is taking up their time and preventing them from going to the gym to exercise. However, this person is placing a lot of value on getting in to shape, so they decide to make a plan to start working out in a month. There are essentially three categories people that would behave differently in this scenario. The first type of person is not time inconsistent, and is in fact consistent with the value he or she places on future time relative to the present. This person places a very high value on outcomes in future time periods and can actually make decisions for him or herself in the present that accurately match decisions he or she would make in the future. 5

Therefore if this person would commit to working out in a month, they would actually start doing so when that future time period became the present.

The second type of person is a time inconsistent, but we can say that they are sophisticated in their assessment of future plans. Even though they really want to get in to shape, the fact of the matter is they do not place enough value on their time one month from now to stick to their own commitment to getting in shape. What makes this type of person unique, however, is that he or she recognized from the beginning that they probably were not likely to stick to their own plans. A sophisticated time inconsistent person is able to also make decisions concerning future periods as if they were in the future period just like a time consistent person. The only difference is that they know they are going to face a preference reversal and will not end up sticking to the plans they make.

The third type of person is naïve in their time inconsistent preferences. This type of person also places a low value on time in the future, but unlike the other two is unable to make decisions as if they were in future periods. Naïve time inconsistent people are only able to make decisions through the lens of the present, and they never stick to the plans they make. In our example, this naïve intertemporal decision maker also wants to get in shape in a month. They judge that even though they are busy now, and likely will be just as busy in a month, they will still be able to make time to go to the gym in one month. They continue believing that they will stick to the plans they have made to get in to shape until one month in the future becomes the present period. 6

When this happens, they are completely surprised that they reverse their preferences and do not go to the gym because they are too busy.

In summary, a time consistent person is someone who always sticks to their future plans, a sophisticated time inconsistent person is someone who knows they won’t stick to their future plans because they do not value the future nearly as much as the present, and a naïve time inconsistent person is someone who is unaware they won’t stick to their future plans because of an inability to judge their own preferences in the future. Keep in mind, however, that this explanation is a simplified version of the concept and its accompanying economic rationale. This paper will also reference hyperbolic discounting, which is a specific type of time inconsistency. The concept of hyperbolic discounting mostly has to do with the steep discount curve that their intertemporal preferences follow. However, this will be explained in more detail in the following sections.

Personal Essay

My research in to the question of whether or not the emerging adults of

Generation Y had different time preferences relative to mature adults was an informative and challenging first glance into the field of behavioral economics research. There were a number of challenges that I faced in designing and writing the paper over the year and a half that I spent working on it. As I mentioned in the section about the discovery of my topic, my introduction to the topic of intertemporal inconsistency and hyperbolic discounting resulted from a class I took called the 7

Economics of Altruism. The first challenge I faced was grasping and comprehending the economic models that explain why individuals make inconsistent intertemporal decisions and why some individuals discount the future at a hyperbolic rate. This took a considerable amount of time, as it was a concept that I was completely unfamiliar with from the start. After I had built an idea of what I wanted my study to look like, I was fortunate enough to have been able to send a survey to a large group of Ohio

University alumni. This was a blessing as it provided a very strong data set with over a thousand observations. With so many points I then was faced with the task of finding and cleaning entries in the data set that were clearly answered insincerely or were obvious outliers.

Following a thorough examination of the data, my next challenge was to familiarize myself with the econometrics necessary to complete the analysis of the data. This was important because a publishable article needs to stand up to criticism of the mathematical models it presents. In order to do so, I read through a book on econometrics that covered the analysis of binomial variables and the concept of probit regressions, of which I was previously unfamiliar. One of the biggest benefits of choosing a topic regarding economics was there was a lot of statistical knowledge to be gained by reading books like the one assigned to me and reading through articles with dense economic theory. It challenged me to take charge of learning something that up to that point I would have felt uncomfortable trying to explain.

After completing the bulk of the work and editing my thesis down to a publishable note with the help of Dr. Paxton, I began the task of submitting the article 8

to a reputable journal of economics. The journal we chose to submit the note to first was Economics Letters, which typically accepts short notes around 5-12 pages. We tailored the article to the characteristics of Economics Letters and submitted the note.

After waiting for about 9 months, however, our article was rejected. Although initially disappointed, I learned that this was simply part of the process of publishing an academic article and it would be a bit far-fetched to have my article accepted by an extremely well regarded journal on my first attempt. In light of that, Dr. Paxton and I decided to look for another journal to publish in that might have previously featured work from authors discussing the economic behavior of emerging adults or Generation

Y. Our research led us to choose the Economic Inquiry, as it appeared that some articles featured in that journal aligned nicely with the findings of my thesis. After once again tailoring the article to the specific format of Economic Inquiry we submitted the article and are awaiting feedback from the journal.

Completing this thesis was a task that took a remarkable amount of thought and effort, as it was the first time I tried to complete anything this academically rigorous. However, from the experience I gained a tremendous deal of insight in to what it takes to explore an idea, complete through research of what has been written about similar topics, design and implement an experiment, craft an article, and ultimately meet the requirements of getting research published in an academic journal.

I believe I was able to make huge strides, both academically and professionally, during the time I spent working on my thesis. As challenges to the limits of my knowledge arose and setbacks occurred during the writing and publishing of the thesis, I was 9

forced to overcome these obstacles in order to complete the project. By doing so, I can definitively say that I have grown as a student and academic and my passion for completing research has grown, as well.

I particularly enjoyed trying to discover and interpret the story that was hidden behind the numbers in my dataset. This might have been the most difficult obstacle, and it was certainly the part of the thesis that took me the longest, but I really enjoyed being able to use my findings to create a snapshot of the behavior of my sample population. This is because that snapshot ultimately added, in one way or another, to the bigger picture of what is known about the topic of the behavior of current emerging and mature adults. The evolution this story was the result of many discussions between Dr. Paxton and I regarding the literature and how it relates our data. Finally, we were able come to the conclusion that we had found a trend that was significant, substantive, and fit nicely into what others have been saying about the topic. For me, this was the most rewarding part of the entire experience.

I would like to thank the support I received from my Director of Studies, Dr.

Raymond Frost, as he helped me along my way to discovering my passion for this subject, and I would also like to thank Dr. Julia Paxton, my thesis advisor, for her patient guidance and knowledgeable instruction, without which I would not have been able to accomplish this work.

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YOUTH AND INEXPERIENCE: DYNAMIC INCONSISTENCY AMONG EMERGING ADULTS BRIAN J. GIBBONSa and JULIA PAXTONb aHonors Tutorial College, Ohio University bDepartment of Economics, Ohio University

Building on research on dynamic inconsistency and age related preferences; this paper introduces the concept that inconsistent intertemporal preferences are directly related to age. The findings from observations of a large sample of college graduates indicate that emerging adults are more likely to exhibit hyperbolic discounting behavior than adults over the age of 30. Among emerging adults respondents, lower incomes and more naïve self-assessments are determinants of hyperbolic discounting behavior. Keywords: Hyperbolic discounting, Emerging adults, Generation Y, Dynamic inconsistency, Intertemporal preferences “There is nothing constant in this world but inconsistency.” -- Jonathan Swift

1. Introduction

A large subset of behavioral economic research in the past has fallen under the broad heading of hyperbolic discounting. At its most basic level, hyperbolic discounting is the act of an individual placing inconsistent valuation on his or her future time following a steep hyperbolic discount curve, rather than an exponential or linear discount curve that place a more consistent value on time. This observation of time inconsistency is of particular relevance to economists, as it can explain why both humans and animals prefer to engage in actions that their future self would not choose in which to engage. The hyperbolic discounting model was introduced by Phelps and

Pollak (1968) as they described time preferences and the national savings rate. The concept of hyperbolic discounting, although disputed in its definition (Rasmusen 11

2008) and its functional form (Rubinstein 2003), has been applied to a multitude of topics.

The literature surrounding hyperbolic discounting is particularly broad in scope and application. Although the applications of hyperbolic discounting have been extensively researched, a gap in the literature exists in regards to intertemporal choice and hyperbolic discounting and their relation to age. The literature has established a connection between intertemporal choice and gender (Breman 2011), however an obvious gap exists that fails to relate hyperbolic discounting tendencies to age cohorts, specifically emerging adults. The present study fills this gap by establishing a relationship between intertemporal choice and the characteristics of different age cohorts.

2. Literature Review

2.1 Hyperbolic Discounting and Intertemporal Preferences

The literature surrounding hyperbolic discounting is particularly broad in scope and application. Early literature regarding intertemporal choice was largely centered on field studies to estimate individual discount rates. However, it was found that it is difficult to draw inferences between an individual’s savings behavior and discount rate. A large amount the experiments done regarding discount rate preferences are now conducted in the laboratory (Benzion, Rapoport, and Yagil 1989). Much debate has taken place over the interpretation of the theory behind hyperbolic discounting, with a different interpretation of the subject resulting from a number of dissenting opinions. 12

Rubinstein (2003) argues that theoretical economists may have abandoned the constant discount function in favor of the hyperbolic discounting too hastily. He showed in his study that by using experimental observations framed in a specific way, one can disprove the applicability of the function to anomalous behavior just as easily as it has been proven in other experiments.

Along the same lines as Rubinstein, Rasmusen (2008) attempts to dispel points that he believes to be common misconceptions about the hyperbolic discounting function. He enumerates six misconceptions that he finds to be the most common: “(1)

Hyperbolic discounting is not about the discount rate changing over time. A constant discount rate is not essential for time consistency, nor does a varying discount rate create time inconsistency. (2) Hyperbolic discounting does not, as commonly used, mean discounting using a hyperbolic function. (3) Hyperbolic discounting really isn't about the shape of the discount function anyway. (4) Hyperbolic discounting is not about someone being very impatient. (5) Hyperbolic discounting is not necessarily about lack of self-control, or irrationality. (6) Hyperbolic discounting does not depend delicately on the length of the time period”. His most important observation is that hyperbolic discounting needs to be modeled in terms of relativistic time rather than absolute time. This implies that when examining a discount rate for three years from now one would classify that point as 3 years from the present rather than simply using the absolute classification of 2017, for example. The shape of the discount curve is irrelevant according to Rasmusen; rather the thing that is most important is that as a 13

future period approaches the present an individual changes his or her consumption preferences in an inconsistent manner.

This conclusion is supported by the findings of Zauberman, Kim, Malkoc, and

Bettman (2009) who explain, from a psychological standpoint, that perception of duration of time can also have a causal effect on intertemporal choices and discount rates. Kim (2006) poses a counter argument to point (5), stating that low self-control is a function of hyperbolic time preferences and that past and present failures of self- control in sticking to a resolution can damage self-confidence. According to Kim, this previously observed psychological occurrence can be so severe that an individual will actually avoid engaging in resolutions they find important in order to avoid the negative outcome if they were to once again fail.

A significant relationship towards divergence from the linear probability- weighting model at the individual level has been established (Epper, Fehr-Duda, and

Bruhin 2011). In other words, individuals are particularly bad at sticking to a linear discount utility function because they are not able to properly predict the probability of effects on them from internal and environmental factors. These findings reinforce

Rasmusen’s conclusion that the shape of the hyperbolic discount curve is irrelevant and Zauberman et al.’s theory by demonstrating that individual probability distortions, rather than underlying individual preferences, have a significant effect on the discount rate. Simply put, an individual may engage in present oriented hyperbolic discounting because of perceived environmental uncertainty (i.e. economic, legal, political climate) rather than to satisfy a pure present-biased time preference (i.e. drug addicts). 14

Understanding that an individual’s discount utility function can be influenced by probability distortions leads to the interesting conclusion that policy could have a significant effect on such function.

Once again, the applicability of intertemporal choice and hyperbolic discounting to a multitude disciplines must be emphasized. If policy can have a substantive effect on discount rates, much could be done with legislation to change individual utility by increasing the present value of future outcomes. Hepburn,

Duncan, and Papachristodoulou (2010) show through their research with fisheries that policy interventions through commitment devices in an environmental context can increase total welfare over time. Time-based preference reversals often are present in environmental contexts. This is because in these markets present gains outweigh future societal repercussions because negative economic consequences from environmental damage are not immediately considered by or enforced upon those creating the negative welfare or externalities.

In regards to health, Scharff (2009) argues that policy established in the United

States has been unsuccessful at fighting the trend of obesity because it does not inherently require any sort of commitment mechanism. He identifies the behavior of people classified as obese to be consistent with hyperbolic discounting tendencies and suggests that a commitment device must be established to “transfer the present value of the long term costs of obesity closer to the point of consumption”. By doing so one would more likely be able to overcome the propensity to consume in the short run. It may be that the most important application of the findings of hyperbolic discounting 15

literature to disciplines outside of theoretical economics is to identify the contexts in which hyperbolic discounting is having a negative effect on welfare and institute commitment products to normalize the present value of long term discount rates.

A recent field experiment done by Ashraf, Karlan, and Yin (2006) is of particular relevance to the current study and will provide a large amount of the theoretical framework on which this study is built. In their study, Ashraf, Karlan, and

Yin employ theoretical survey questions similar to those posed in previous studies

(Benzion et. al, 1989) such as, “Would you prefer to receive P200 (Philippine pesos) guaranteed today, or P300 guaranteed in 1 month?” and “Would you prefer to receive

P200 guaranteed in 6 months, or P300 guaranteed in 7 months?” in order to measure time-preferences, as well as time preference reversals. Using this survey the researchers are able to measure three characteristics among their sample set: impatience, present-biased time inconsistency, and future-biased time inconsistency.

After identifying those among the sample who display time inconsistent preferences, a savings commitment device was marketed to a trial group. A significant effect for the adoption of the product was found among women who were classified as hyperbolic discounters. These women experienced a positive increase in saving, yet there was an indeterminable effect on welfare for the household.

2.2 Characteristics of Generation Y

Comparable experiences such as economic, political and social events among age groups form similar characteristics, values, and opinions among generational 16

cohorts (Petroulas, Brown, and Sundin 2010). Research in the fields of marketing and management has established details on the general characteristics of Generation Y, however relatively little research exists applying these concepts to the field of economics. Petroulas et. al (2010) stated that Generation Y has a lack of organizational loyalty and a short term goal focus. This categorization is reinforced by

Southard and Lewis (2004) who state that the cohort prefers instant gratification rather than the long-term investment of time and effort. Tulgan (2009) submits that

Generation Y harbors a sense of immediacy as a result of growing up with a never before seen amount of technology.

Another characteristic established through research is that Generation Y has been influenced by well-educated baby boomer parents (Martin and Tulgan 2002).

Twenge and Campbell (2008) find that members of Generation Y are higher in narcissism, higher in self-esteem, have less need for social approval, and have a higher external locus of control. Generation Y is known as the most educated and culturally diverse generation in history. This generation is exceptionally tolerant toward a variety of different diverse lifestyles.

A recent study shows that emerging adults in their 20’s and 30’s have 40 percent less real accrued wealth than their parents did at the same age, despite the fact that income has doubled in the past 25 years (Steuerle, et. al., 2013). With easy access to credit and college loans, recent college graduates are struggling to pay off debt and are delaying the purchase of homes and cars (Van Horn 2012). Psuedo-panel data has also shown that the members of Generation Y rely on the use of credit more heavily 17

and repay less of their balance than members of older generations (Jiang and Dunn

2013).

Taking in to consideration all of these characteristics, it is clear that Generation

Y has entered early adulthood in a world much different from that of previous generations. Experiences during their development have caused them to form distinct characteristics that could potentially have some effect on time preference. The academic observations of Gen Y from the literature concerning their mounting debt repayments, their short term goal focus, their higher external locus of control, and their experiences growing up with technology influenced the current study by providing a rationale behind why Generation Y might potentially have different intertemporal preferences than mature adults.

2.3 Age Related Time Preference

A growing wealth of literature has emerged regarding the characteristics of

“emerging adults”, or those individuals ages eighteen to twenty-five and beyond who do not classify themselves as an adult, including their risk preferences, financial behavior, and time preferences. The study of these characteristics is of particular relevance to those interested in the topic of hyperbolic discounting. Arnett (2001) identifies emerging adults as those ages 18-25 who have less stable financial situations, interpersonal relationships, living arrangements, cognitive and emotional development, and religious beliefs. He also states that the transition from adolescence to adulthood is a slow and incremental process for Americans, extending in many 18

cases into the late twenties. Arnett finds in his study that there is a significant difference in opinion between adolescents and those already in midlife adulthood over whether social norm violations were a part of the transition to adulthood. Adolescents and emerging adults viewed violations of norm compliance as an insignificant factor in the classification as an adult, whereas young to midlife adults viewed compliance with societal norms to be paramount to the classification as an adult.

In a recent study, a correlation between sensation-seeking scores and problematic financial behavior for emerging adults was established (Worthy,

Jonkman, and Blinn-Pike 2010). Robb (2011) presents similar findings showing that increasing financial knowledge has a direct impact on prudent debt management through credit card use in college students. The findings of these two studies are solidified through a national survey that controlled for demographic and financial backgrounds (Gutter and Copur 2011). This survey and the resulting study present the idea that time orientation towards the future and risk aversion can increase social and economic welfare, and once again found that higher levels of financial knowledge and risk aversion were positively related to financial welfare among emerging adults.

Consequently, overall welfare was higher as it is a function of financial welfare.

Developing the ideas established by the literature further, one could make the observation that current emerging adults and recently self-classified adults of

Generation Y have developed particularly poor financial habits relative to other generations because of increasing access to credit and underdeveloped financial literacy. 19

In so much as can be observed through the literature, recent research has failed to explain if these present-biased trends have had an effect on the discount utility of the cohort as a whole. Nelson and Barry (2005) establish that those who self-classify as “adults” engage in less risk-taking behaviors compared to their “emerging adult” peers who are self-classified using the same criteria. When taking this into account with the initial proposal, one finds that a very interesting and possibly significant tendency towards present-oriented intertemporal choice among the emerging adults and young adults of Generation Y.

3. Dynamic Inconsistency Theory

Traditional models of time consistent financial behavior assume an exponential discount function. The exponential discount factor is given as:

=1(1+) (1) where δ is the discount rate. Preference reversals have been mathematically defined by a number of hyperbolic and quasi-hyperbolic discount functions (Anderson, et. al.,

2011). In its simplest form, the hyperbolic discount function assumes a discount factor that can be written as:

=1 (2)

With a discount rate defined as:

=(1)−1 (3) 20

While numerous functional forms exist to define declining discount rates, quasi- hyperbolic discounting (Loewenstein and Prelec, 1992; Laibson, 1997) is relevant to empirical tests of dynamic inconsistencies since it allows for a discrete time-value function. The quasi-hyperbolic discount factor is defined as:

=(1+)(−1)−1 (4)

For t>0. Consistent with discrete preference reversals, a rapidly decreasing discount rate occurs when β<1 in the short run and then approaches δ as the initial drop in the discount factor decreases.

Empirical tests of dynamic inconsistency attempt to capture preference reversals through survey questions. Ashraf, Karlan, and Yin (2006) employ theoretical survey questions similar to those posed in previous studies (Benzion,

Rapoport, and Yagil 1989) such as, “Would you prefer to receive P200 guaranteed today, or P300 guaranteed in 1 month?” and “Would you prefer to receive P200 guaranteed in 6 months, or P300 guaranteed in 7 months?” in order to measure time- preferences, as well as time preference reversals.

Building off the previous literature, this study aims to discover if there is a statistically significant difference between hyperbolic discounting tendencies of the emerging adults of Gen Y compared to mature adults over the age of 30. Considering what was previously discussed about the characteristics of Gen Y, it is hypothesized that a difference in intertemporal inconsistency does exist because of Gen Y’s bias towards immediate gratification and poor financial habits. It is likely that members of 21

Gen Y will be more naïve about their intertemporal preferences and, therefore, experience preference reversals more frequently than their older counterparts.

4. Data and Method

This study introduces a completely new data set that includes a number of variables that describe the demographics, intertemporal preferences, and financial knowledge of a large number of college graduates. The data was obtained through a short survey that was sent through e-mail to a sample of Ohio University graduates of all ages. 1,205 completed responses were recorded. Figure 1 shows the frequency of survey respondents by age. It is important to note that sample distribution is not representative of the true population but just those graduates who willingly participated in the survey. The data was stratified into two categories with 485 emerging adults between the ages of 21 to 30 making up the emerging adult category and 720 observations making up the mature adult category, so even though it would appear that the age data is skewed to the left, the mature adult category contains 235 more responses.

Figure 1: Frequency of response by age 22

Included in the survey were questions used to establish intertemporal preferences among the sample similar to those established previously in the literature by Ashraf et.al. The dependent variable, time inconsistent impatience (hyperbolic discounting), was defined as someone who would choose to receive $100 immediately, as opposed $110 in one month; but then when given the choice to pick between receiving $100 in six months and $110 in seven months, they reverse their decision and choose to wait for the $110 dollars. Other relevant variables are defined in Table 1. Actual money was not disbursed to participants; instead they were made aware that the scenario was purely hypothetical. 23

Table 1: Definitions of Key Variables Impatient now Responded that they would rather receive $100 now than $110 in one month Impatient in future Responded that they would rather receive $100 in six months than $110 in seven months Time consistent impatient Responded that they would receive $100 now and $100 in six months rather than waiting a month during both scenarios to receive the $110 Time inconsistent impatient Responded that they would prefer to receive $100 now but six months in the future they would rather wait one month to receive the $110 Patient now Responded that they would rather wait to receive $110 in one month than $100 now Patient in future Responded that they would rather wait to receive $110 in seven months than $100 in six months Time consistent patient Responded that they would wait to receive $110 in a month and $110 in seven months rather than receiving the $100 immediately and in six months Time inconsistent patient Responded that they would wait to receive $110 in a month but six months in the future they change their mind and prefer to receive the $100 immediately over the $110 in seven months Stick to plans How often a respondent sticks to plans in the present on a scale of 1-10 Future stick to plans How often a respondent believes they will stick to plans in the future on a scale of 1-10 Naïve optimist A respondent who classified himself or herself as a person who thinks they will stick to plans then they do not actually do so. Naïve pessimist A respondent who classified himself or herself as a person who thinks they will not stick to plans then they do actually stick to them Sophisticated assessment A respondent who is able to accurately assess his or her ability to stick to plans they have made. 24

The independent variables considered in this study consisted of demographic and behavioral self-assessments, as well as other factors such as economics education and time respondents took to fill out and return the survey. As Figure 2 indicates, while just less than half of the adult respondents were male, considerably more females in the Gen Y group answered the survey (63%). Indeed, one of the demographic issues with our sample is that there was not an equal distribution of observations between male and female respondents. However, this is not a representative sample of the population of all college graduates, but rather an interesting independent look in to the differences of intertemporal preferences of emerging adults versus mature adults.

Figure 2: Percent Male 50.0% 45.6% 45.0% 40.0% 37.3% 35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% Mean Gen Y Mean Adults

In order to capture consistency in non-financial activities, the following questions were asked: “When you make plans, (saving, weight loss, gym, vacation, etc.) how often do you stick to them?” and “If you were to make a lifestyle changing 25

plan today (saving, weight loss, gym, vacation, etc.), how likely would you be to stick to it?” If a respondent used past behavior to predict their future success in sticking to goals, they were classified as sophisticated. However, if the two answers diverged, respondents were labeled naïve (with a subdivision of naïve pessimist and naïve optimist). A graphical representation of this variable is presented in Figure 3.

Figure 3: Sophisticated/Naïve Explanatory Figure

26

Figure 4: Household Income

As would be expected, the household income for adults is much higher than that of the emerging adults of Gen Y. This is because adults are likely already married and have two earners in the household versus an unmarried emerging adult earning close to an entry-level salary. This difference in household income could be one of the contributing factors as to why Gen Y might choose to receive the $100 now instead of waiting for the $110 dollars in the future.

As noted in Figure 3, respondents were given the chance to rate themselves numerically on their ability to stick to life changing plans in the present as well as in the future. The quantitative results of this self-assessment are shown by age group below. 27

Figure 5: Self-assessment of Likelihood to Stick to Plans 7.05 Stick to plans now Stick to plans in the future 7.00 7.00 7.00 7.00 7.00

6.95 6.92 6.91 6.90 6.90 6.86 6.85

6.80

6.75 Mean Gen Y Median Gen Y Mean Adults Median Adults

Although there are not significant discrepancies in the self-assessments of Gen

Y versus adults, we can observe that adults rank themselves slightly lower at their ability to stick to plans on average. Adults identify that they are .06 less likely to stick to plans in the present on a scale of 1-10.

Figure 6: Percent of Sample Classified as Naïve Optimist or Naïve Pessimist

25.0% Naïve optimist Naïve pessimist 20.6% 20.0% 17.9% 18.3% 15.4% 15.0%

10.0%

5.0%

0.0% Mean Gen Y Mean Adults 28

Examining the types of naïveté between the two age groups shows that adults are less likely to be both naïve optimists and naïve pessimists. This would make sense logically, as one would expect adults to understand their own behavior and preferences better as they progress through their lives. This is confirmed below in Figure 7, which shows that adults are in fact more sophisticated in their self-assessment.

Figure 7: Percent of Sample Classified as Sophisticated versus Naïve

100.0% Sophisticated Naive

80.0% 66.3% 61.4% 60.0%

38.6% 40.0% 33.8%

20.0%

0.0% Mean Gen Y Mean Adults

Therefore, when taking the entire picture of the self-assessment into consideration, we can observe that adults are slightly less likely to stick to plans in the present but are much more likely to be sophisticated, in general, as well as less likely to be naïve optimists and naïve pessimists. The statistical significance of this discrepancy will be tested. 29

At first glance of the mean time preferences by age group, shown in Figure 8, it can be seen that there are noticeable differences among the mean preferences in the time inconsistent impatient category and the time consistent impatient category.

Figure 8: Mean Time Preference by Age

Because of this, T-tests were run to establish if there was a statistically significant difference between members of Gen Y and adults in a number of categories. The results of this test are shown in Table 2. 30

2 31

A number of interesting statistical divergences were found from the t-tests. At the 10% significance level it was found that members Gen Y were less likely to be sophisticated self-assessors and they were more likely to make a naïve self- assessment. At the 1% significance level it was found that income and time consistent impatience were significantly different and at the 5% significance level time inconsistent impatience was found to be different between the two groups. These initial results were extremely important to the study. The statistical divergence in the t- test confirmed the original notion developed from the review of the literature that the emerging adults of Generation Y do indeed exhibit different characteristics than adults in other generational cohorts.

5. Results

Before further testing took place, it was hypothesized that three of the factors measured by the survey would have an effect on time inconsistent impatient behavior.

It was deduced that both a higher age and greater financial savvy, measured by the number of economics courses taken in college, would decrease the likelihood of hyperbolic discounting for the respondent, whereas a naïve self-assessment would increase the likelihood of a person being classified as time inconsistent impatient.

In order to test these determinates a probit regression model was estimated.

This regression model corrected for conditional heteroskedasticity in the independent variable economics courses. The model attempted to find significant factors contributing to the discrepancy in time preference between the two age groups, by 32

testing for significant factors among the entire population, as well as significant factors for Gen Y, and significant factors for adults. By doing so, it distinguished what factors were determinants of hyperbolic discounting for the entire population, compared to what were significant determinants for the Gen Y and mature adult cohorts. The results of the model are shown in Table 3. 33

3 34

In interpreting these results it can be seen that a number of factors have an effect on whether or not any respondent within the population would be identified as a time inconsistent impatient hyperbolic discounter. As predicted, age, financial savvy, and ability to accurately self-assess personal time preferences all significantly affect time inconsistent impatience. As mentioned previously, the literature indicates that an increase in age, an increase in financial savvy, and a more sophisticated self- assessment of time preference would all potentially decrease the likelihood that an individual would be time inconsistent impatient. These are all logical inferences as an increase in age might cause someone to understand their own behavior better, having a greater understanding of discount rates and utility over time would provide an individual insight into the economics of decision-making, and being able to place yourself in to future periods to make future decisions, as sophisticated assessors are able to do, would also decrease time inconsistent behavior and preference reversals.

Between the two individual age groups, however, different variables are found to be significant. This indicates that there are indeed fundamental differences between why an emerging adult might be time inconsistent impatient as compared to why an adult might be time inconsistent impatient. For Gen Y, income is a statistically significant determinant of hyperbolic discounting, which is insignificant for mature adults and the full sample. Hyperbolic discounters may be more likely to have a present-based time preference because they have less income in comparison to their peer group. In fact, the model estimates that every increase of $1,000 in household income reduces the likelihood of being classified as a hyperbolic discounter by 0.51% 35

for those respondents under the age of 30. Hyperbolic discounting is also a function of both types of naïve self-assessment for the respondents in Gen Y. Both naïvely optimistic and naïvely pessimistic self-assessments are linked to hyperbolic discounting compared to respondents who have a sophisticated assessment of their ability to follow through with plans they have made.

Among mature adults over the age of 30, only being naïve optimistic is linked to hyperbolic discounting. In addition, for mature adults, economics education significantly reduces the likelihood of time inconsistent impatient preferences. By having taken just one more economics class than an adult peer, members of this sample reduced the likelihood of being time inconsistent impatient by 49.4%.

6. Discussion

The results of this study introduce two interesting and new results: 1) There is a higher prevalence for time inconsistent impatience among the emerging adults of

Gen Y than observed in mature adults and 2) There are statistically significant differences in the determinants for hyperbolic discounting between the two groups.

This begs the question of why members of Gen Y are deeply discounting the near future. It would seem that 19.2% of the sample of members of Gen Y would like to be patient in the future, however when the future becomes the present they become eager for gratification and experience a preference reversal. There are two reasons for this proclivity towards preference reversals. One is that they are inaccurate self-assessors – 36

likely directly related to age and experience, and two is that a potentially insufficient amount of training in economics has had an effect on their intertemporal preferences.

Without panel data to test intertemporal preferences over many generational cohorts, it is impossible to statistically distinguish whether the effects on intertemporal behavior found this study were cohort effects unique to Gen Y, or whether the effects were simply related to age and would be common to a member of any generation in the stages of emerging adulthood. It is indeed possible that all emerging adults from the ages of 21-29, regardless of their generation, are more likely to be time inconsistent impatient because they simply have not had the same amount of life experiences that their adult counterparts have had, leading them to be less- sophisticated self-assessors and more unaware of their preferences over time. Building off of previously mentioned research, however, it is hypothesized that Gen Y does indeed have unique behavioral characteristics that make them more likely to be hyperbolic discounters. There are a number of economic, political, and social reasons

(Petroulas et. al, 2010) that potentially have created a distinct characteristic in Gen Y towards a significantly higher tendency of hyperbolic discounting and intertemporal inconsistency, although once again this cannot be argued with any statistical backing.

First of all, Gen Y has grown up absorbing information about events in their lives at a much higher speed and quantity than previous generations. Now that they are entering adulthood, the speed of information is practically instantaneous. This change in technology could be affecting the intertemporal preferences of one of its largest groups of users, making Gen Y much more impatient in the present and might also be 37

impeding their ability to make decisions about the future as if they were in future periods. This point is supported by Tulgan’s (2009) assertion that Gen Y harbors an extreme sense of immediacy because of technology. Secondly, access to credit and an increasing reliance on debt to fund higher education that was discussed by Van Horn

(2012) has created a patience trap into which Gen Y has fallen. It is easy to surmise that among young college graduates there would be a desire to delay rewards in the future and wait for $110 dollars. However, because of what we will call the “Gen Y debt trap”, which includes payments that are due for loan debt and credit card balances, members of Gen Y are more likely to be faced a preference reversal because of their lack of financial literacy. This is especially true given that they have a more naïve understanding of their intertemporal preferences.

Ashraf et al. have shown that hyperbolic discounters are significantly more likely to adopt commitment devices to increase personal savings. This could indicate that current emerging adults in Gen Y would also be significantly more likely to adopt financial commitment devices as well. As discussed, it is not known whether or not

Gen Y will retain this time inconsistence throughout their lives, so it cannot be said if they would continue to adopt these product when they enter mature adulthood. For the time being, however, marketing formal commitment devices toward the reduction of debt or proper budgeting could potentially help members of Gen Y overcome intertemporal inconsistency and improve financial welfare. Furthermore, it may make sense to market financial commitment products not only to Gen Y but also future generations of emerging adults. It is likely then that they will exhibit similar 38

characteristics of immediacy, impatience, and reliance on debt to fund higher education.

Although the results of this study cannot conclusively state that Generation Y is unique in their intertemporal behavior as emerging adults without incorporating panel data, it does provide a theoretical foundation for a study to examine such a question in the future. By viewing the results of this study through the framework

Ashraf et al. have established and the lens of what is already known about the characteristics of emerging adults, it is predicted that the time inconsistent impatient members of Gen Y would indeed have a preference towards financial instruments requiring commitments and would be more likely than their consistent peers in their generational cohort as well as other adults to adopt such instruments. This prediction could also be the topic of a follow-up study. If time inconsistent impatient behavior is indeed more prevalent among all generations of emerging adults versus mature adults, it is likely that Gen Y will be slower to grow out of this behavior as they enter mature adulthood because of the burden of their debt and sense of immediacy.

7. Conclusion

The results of this study built upon the hyperbolic discounting literature by showing that the emerging adults of Gen Y are more likely to be dynamically time inconsistent and that the determinants of their behavior vary from adults over the age of 30. Age and training in economics were found to be significant in explaining dynamic inconsistency among college graduates. Within Generation Y, those who 39

were naïve in their self-assessments life changing plans were more likely to demonstrate time inconsistent preferences compared to adults over the age of 30.

Understanding the unique behavioral profiles and time preferences of age groups could be helpful in devising financial products that match the demand of the members of those groups. In this case, we would predict that members of Gen Y would be more likely to adopt commitment devices to counter their present-based intertemporal bias.

Future research will build off of this study incorporating data on the financial education that Gen Y has received compared to mature adults, as well as behavior related to financial products such as loans and credit cards.

Although the hyperbolic discounting is a relatively new theory in the field of economics, its importance should not be underestimated. This study has shown that determinates of hyperbolic discounting tendencies differ, even among highly educated college graduates. It has already been shown that by identifying hyperbolic discounters among a population and getting those people to commit to devices that help eliminate preference reversals can improve financial welfare. However, these types of studies have only been executed in a few very specific contexts. It is important for economists to continue to identify the determinants of hyperbolic discounting among different populations and across different fields and subjects.

Future studies involving members of Gen Y could incorporate these findings about generational time preferences to create commitment devices that aim to reduce the frequency of negative preference reversals or improve the retention to positive choices that individuals have committed to in the future. 40

Appendix 1: Economic Behavior Survey

Economic Behavior Survey

This 3-minute survey is being used for research by Honors Tutorial students for an Ohio University economics class. This is not a commitment or a request to donate any money to Ohio University. There are no right or wrong answers and all information will be kept confidential.

Purpose

The purpose of the survey is to better understand economic behavior and preferences regarding the timing of financial decisions. Thank you for your participation!

1. Please enter the ID survey code listed in the email sent to you. 2. Given the choice, would you rather receive $100 today or $110 in one month? 3. Given the choice, would you prefer to donate $50 to a good cause today or $55 in one month? 4. When you make plans, (saving, weight loss, gym, vacation, etc.) how often do you stick to them? Use the scale of 1 to 10, with 1 being never sticking to plans and 10 being always sticking to plans. 5. Age: 6. Sex: 7. Approximate household income: 8. If you were to make a lifestyle changing plan today (saving, weight loss, gym, vacation, etc.), how likely would you be to stick to it? Use the scale of 1 to 10, with 1 being definitely would not stick to the plan and 10 being definitely would stick to the plan. 9. Given the choice, would you rather receive $100 in 6 months or $110 in seven months? 10. Given the choice would you prefer to donate $50 to a good cause in 6 months or $55 in seven months? 11. How much do you plan on donating to Ohio University in 2013? This is a non- binding, hypothetical question. 12. To the best of your recollection, how many college economics classes did you take? 41

Appendix 2: Other Data Set Variables Visualized by Age Group

Figure 9: Age Demographics by Group

Figure 10: Days to Complete Survey

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Supplemental Research and Observations

1. Determinants and discussion of other intertemporal preferences

Although the majority of the discussion of this topic revolved around time inconsistent impatient behavior, the three other types of time preferences established in this study also merit discussion. Those preferences are time inconsistent patient, time consistent impatient, and time consistent patient. The same probit model that was used to determine significant factors to time inconsistent impatience was also used to estimate the significance of the variables on these three time preferences. The same independent variables that were used in the initial regression were also used to estimate the three individual models.

1.1 Time Inconsistent Patient

Time inconsistent patient respondents prefer to wait for a month in the present to receive $110 in a month. In the future, however, the respondent experiences a preference reversal and decides to receive $100 in six months instead of waiting for another month. This behavior is extremely unusual and does not conform to typical discount models. It is difficult to explain why anyone would have a higher discount rate in the future than they do in the present unless there were some unusual circumstances to explain this preference reversal. For example, if someone was employed now but did not expect to have steady income in 6 months they might choose to delay the payout for a month in the present, but then take the payout immediately in the future because of loss of income. Without qualitative explanations 43

in conjunction with survey question answers it is impossible to surmise why respondents chose the responses to make them time inconsistent patient.

Table 4: Time Inconsistent Patient Behavior by Age

From the model we can also see that it is particularly difficult to determine what makes somewhat more or less likely to be time inconsistent patient. Only two variables were statistically significant. According to the estimate there was a 69.1% less likelihood of being time inconsistent patient if the respondent was a naïve optimist in Gen Y, which was significant at the 10% level. Also, for every economics class a member of the sample took they reduced their likelihood of being time inconsistent patient by 26.07%. This result was significant at the 5% level. This result is logical, as training in economics and understanding of interest rates might dissuade a person from making such an unusual intertemporal decision.

1.2 Time Consistent Impatient

Respondents who indicated that they would rather receive $100 now and $100 in six months rather than waiting a month during both scenarios to receive $110 were classified as time consistent impatient. Theoretically, this would be the type of person 44

that knows that they will need the money immediately in both the present period and in the future. Given that Gen Y has less stable incomes because of problems with debt and less secure jobs, one would guess that age and income would both be a determinant of time consistent impatience. Also an understanding of interest rates might decrease time inconsistent impatience, as someone with more economics education might realize the opportunity of holding out a month for the month to gain a

120% annualized interest rate.

Table 5: Time Consistent Impatient Behavior by Age

When analyzing the probit results in Table 5, however, we see that this is not the case. The determinants of hyperbolic discounting among age groups do not properly explain what causes time consistent impatience with any significance. The only result that is significant at the 10% level is that males in Gen Y are 21.16% less likely to be time consistent impatient than females in their cohort.

1.3 Time Consistent Patient

Respondents that indicated they would wait to receive $110 in a month and $110 in seven months rather than receiving the $100 immediately and in six months were 45

classified as time consistent patient. The determinants of time consistent patience should be the opposite of time consistent impatience.

Table 6: Time Consistent Patient Behavior by Age

The results from this probit test show a strong relationship between males in

Gen Y and time consistent patience. Males in Gen Y were 27.27% more likely to be time consistent patient, and these results were significant at the 1% level. There was also a significantly positive relationship between income and time consistent patience in Gen Y. This means that the people in Gen Y with more money than their peers are more likely to hold out for the larger $110 payout. The only other significant determinant was an inverse relationship between naïve pessimists and time consistent patience for the entire sample. This means that if you do not think you are going to stick to plans and then you do, you are predicted to 22.81% less likely to be patient in your decision to delay receiving the payout.

By considering the determinants of the other three potential time preferences, we observe one interesting fact that was not apparent in the initial analysis; namely that the males of Gen Y are much more consistent in their intertemporal behavior than 46

females in Gen Y. This is an interesting finding because although there is not a significant relationship between being a male and hyperbolic discounting, there is a significant relationship between being a male and being patient. Drawing on the conclusions made on in the discussion section, it may be primarily the females who are experiencing problems with patient behavior. However, the issue again arises that only 37.3% of the Gen Y sample respondents were male. There might be a grouping of female respondents that are exerting leverage on the model that are causing bias not representative of the population.

2. Gen Y and giving Another aspect I measured in my survey was the intertemporal donation preferences of Gen Y versus mature adults. Once again, using the established framework from Ashraf et al. (2006) for identifying time inconsistency combined with the methodology of Breman’s (2011) field experiments regarding altruism and intertemporal choice, I had hoped to also answer the question of whether a significant difference exists between intertemporal preferences of the emerging adults of

Generation Y relative to other adults and also how those preferences affect the propensity to donate to a non-profit institution relative to mature adults. In her study,

Breman was able to show that giving existing charitable donors a choice of increasing their monthly donation amounts over a period of one or two months rather than immediately increased donations significantly, and also was favored by donors.

Donors were able to experience a net change in positive utility from donating from a 47

larger “warm glow” effect, a positive externality of charitable donation, while simultaneously experiencing less negative utility as they parted with their money because of unequal discount rates between the present and 1 or 2 months in the future.

The organization also experienced positive utility as total donations increased significantly and sustainably. Unfortunately, Breman does not survey participants in her study to gather data on time preferences to identify those who would be classified as hyperbolic discounters. Unlike Breman’s experiment, I wanted analyze the relationship between the time preferences of the subjects surveyed, their donation history, and age. My initial survey included hypothetical questions that were similar to the questions about how much a respondent would like to receive. This time, however, they were asked would they rather donate $50 to a charity today or $55 in a month. However, the results of a second survey mailed six months after the first survey that included actual giving numbers versus expected giving numbers were not robust enough. Therefore, it was difficult to draw conclusions about the sample’s overall intertemporal giving preferences. Without qualitative data there is not any definitive way of explaining why people would choose one donation option over another. For instance, maybe someone chose to donate more in both periods simply because they like to donate a lot of their income to charity not because they are patient, while another individual might have chosen to donate $50 both times because they do not like to donate money to charity, not because they are impatient.

The data that was collected on expected giving does merit analysis, however.

The sample seemed to exhibit an inclination towards inconsistency in the responses in 48

giving hypothetical money, similar to receiving hypothetical money. Therefore, I estimated a model using the same determinates as our receiving models to observe whether or not the same variables had an effect on time inconsistent impatient giving preferences. For clarification, there is a slight monetary difference between time inconsistent impatient giving and time inconsistent impatient receiving. A time inconsistent impatient giver is one who responded that they would like to donate $50 today instead of $55 in one month, but reverse their decision and state that they would prefer to donate $55 in seven months instead of $50 in six months. Once again, I divided the sample into emerging adults and mature adults to observe the differences between Gen Y and older generations. Before I estimated the model, I ran another model to test whether being inconsistent impatient in receiving preferences determined inconsistent impatient giving preferences. The correlation was so high between the two time preferences that the variable was removed because of lateral collinearity.

Table 7: Time Inconsistent Impatient Giving Behavior by Age

From these results we can see that once again there are differences in the determining factors of time inconsistent impatient behavior among age groups. For 49

Gen Y, age and naïveté both played a significant role in influencing these inconsistent preferences. However, the same cannot be said for mature adults or even the full sample. The only other significant variable in these two groups is income among the whole sample, which shows that as income increases time inconsistent impatient preferences decrease slightly.

Even though the results of the survey concerning giving preferences are not as detailed, there are still interesting implications to consider. Future studies can access the findings of this study and use them as building blocks to understand the giving preferences of the emerging adults of Gen Y versus mature adults. Much like with receiving money, if there are differences in the determinates of inconsistent giving for emerging adults, organizations asking for money could recognize those preferences and be able to maximize utility from the inconsistent behavior. For example, a 26 year old might have good intentions to donate $55 to a charity in six months, but when six months becomes the present he or she only donates $50 because of their naïve ability to stick to their own plans. The charity could take advantage of these good intentions by having the 26 year old commit to donating $55 in six months during the present period, rather than asking in six months’ time. Doing so could possibly increase both donations to the charity itself and the satisfaction of the time inconsistent donor as they fulfill their original intentions.

50

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This thesis has been approved by:

The Honors Tutorial College and the College of Business

______

Dr. Julia Paxton

Assistant Professor, Economics

Thesis Adviser

______

Dr. Raymond Frost

Honors Tutorial College, Director of Studies

Business Administration

______

Jeremy Webster

Dean, Honors Tutorial College

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