Mental accounting is the set of cognitive operations used by individuals and households to organize, evaluate, and keep track of financial activities Making use of research on this topic over the past decade, this paper summarizes the current state of our knowledge about how people engage in mental accounting activities Three components of mental accounting receive the most attention This first captures how outcomes are perceived and experienced, and how decisions are made and subsequently evaluated The accounting system provides the inputs to be both ex ante and ex post cost–benefit analyses A second component of mental accounting involves the assignment of activities to specific accounts Both the sources and uses of funds are labeled in real as well as in mental accounting systems Expenditures are grouped into categories (housing, food, etc) and spending is sometimes constrained by implicit or explicit budgets The third component of mental accounting concerns the frequency with which accounts are evaluated and ‘choice bracketing’ Accounts can be balanced daily, weekly, yearly, and so on, and can be defined narrowly or broadly Each of the components of mental accounting violates the economic principle of fungibility As a result, mental accounting influences choice, that is, it matters Copyright © 1999 John Wiley & Sons, Ltd

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Mental accounting matters

We develop estimation methods that use the amount of selection on the observables in a model as a guide to the amount of selection on the unobservables. We show that if the observed variables are a random subset of a large number of factors that influence the endogenous variable and the outcome of interest, then the relationship between the index of observables that determines the endogenous variable and the index that determines the outcome will be the same as the relationship between the indices of unobservables that determine the two variables. In some circumstances this fact may be used to identify the effect of the endogenous variable. We also propose an informal way to assess selectivity bias based on measuring the ratio of selection on unobservables to selection on observables that would be required if one is to attribute the entire effect of the endogenous variable to selection bias. We use our methods to estimate the effect of attending a Catholic high school on a variety of outcomes. Our main conclusion is that Catholic high schools substantially increase the probability of graduating from high school and, more tentatively, college attendance. We do not find much evidence for an effect on test scores.

Selection on Observed and Unobserved Variables: Assessing the Effectiveness of Catholic Schools

In this paper we measure the effect of Catholic high school attendance on educational attainment and test scores. Because we do not have a good instrumental variable for Catholic school attendance, we develop new estimation methods based on the idea that the amount of selection on the observed explanatory variables in a model provides a guide to the amount of selection on the unobservables. We also propose an informal way to assess selectivity bias based on measuring the ratio of selection on unobservables to selection on observables that would be required if one is to attribute the entire effect of Catholic school attendance to selection bias. We use our methods to estimate the effect of attending a Catholic high school on a variety of outcomes. Our main conclusion is that Catholic high schools substantially increase the probability of graduating from high school and, more tentatively, attending college. We find little evidence of an effect on test scores.

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The core methods in today's econometric toolkit are linear regression for statistical control, instrumental variables methods for the analysis of natural experiments, and differences-in-differences methods that exploit policy changes. In the modern experimentalist paradigm, these techniques address clear causal questions such as: Do smaller classes increase learning? Should wife batterers be arrested? How much does education raise wages? Mostly Harmless Econometrics shows how the basic tools of applied econometrics allow the data to speak.In addition to econometric essentials, Mostly Harmless Econometrics covers important new extensions--regression-discontinuity designs and quantile regression--as well as how to get standard errors right. Joshua Angrist and Jorn-Steffen Pischke explain why fancier econometric techniques are typically unnecessary and even dangerous. The applied econometric methods emphasized in this book are easy to use and relevant for many areas of contemporary social science.

 An irreverent review of econometric essentials
 A focus on tools that applied researchers use most
 Chapters on regression-discontinuity designs, quantile regression, and standard errors
 Many empirical examples
 A clear and concise resource with wide applications

/pdf/mostly-harmless-econometrics-3v96x4yjch.pdf

Mostly harmless econometrics

This paper undertakes an assessment of a rapidly growing body of economic research on financial literacy. We start with an overview of theoretical research which casts financial knowledge as a form of investment in human capital. Endogenizing financial knowledge has important implications for welfare as well as policies intended to enhance levels of financial knowledge in the larger population. Next, we draw on recent surveys to establish how much (or how little) people know and identify the least financially savvy population subgroups. This is followed by an examination of the impact of financial literacy on economic decision-making in the United States and elsewhere. While the literature is still young, conclusions may be drawn about the effects and consequences of financial illiteracy and what works to remedy these gaps. A final section offers thoughts on what remains to be learned if researchers are to better inform theoretical and empirical models as well as public policy.

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The Economic Importance of Financial Literacy: Theory and Evidence

This paper summarizes the authors work on the effect of IRA and 401(k) contributions on net personal saving. They consider many different nonparametric approaches to controlling for heterogeneity in individual saving behavior and conclude that the weight of the available evidence suggests that contributions to both IRAs and 401(k)s largely represent new saving. The authors devote particular attention to reconciling their results with the findings in other studies that reach different conclusions, sometimes using the same databases that the authors analyze. Methodological limitations that undermine the reliability of results in other studies explain many of these disparities.

https://pubs.aeaweb.org/doi/pdfplus/10.1257/jep.10.4.91

How Retirement Saving Programs Increase Saving

https://www.nber.org/system/files/working_papers/w4391/w4391.pdf

Do 401(k) contributions crowd out other personal saving

The majority of the wealth of most elderly is in the form of housing equity. It is often claimed that many elderly would transfer wealth from housing to finance current consumption expenditure, were it not for the large transaction costs associated with changes in housing equity. This is the rationale for a market in reverse annuity mortgages. This paper considers whether transaction costs, understood to include the psychic costs associated with leaving friends, family surroundings, and the like, prevent the elderly from making choices that would improve their financial circumstances. The analysis considers jointly the probability that an elderly family will move and the housing equity that is chosen when a move occurs. The results are based on the decisions of the Retirement History Survey sample between 1969 and 1919. Relative to the potential gains from a reallocation of wealth between housing equity and other assets, transaction costs are very large. Nonetheless, the effect on the housing equity of the elderly is very small. On balance, were all elderly to move and choose optimum levels of housing equity, the amount of housing equity would be increased slightly. Most elderly are not liquidity constrained. And contrary to standard formulations of the life cycle hypothesis, the typical elderly family has no desire to reduce housing equity. The desired reduction of housing equity is largest among families with low income and high housing wealth, but even in this case the desired reductions are rather small. And these desired reductions are more than offset by the desired increases of other families, especially those with high income and low housing wealth. Thus, consistent with the previous findings of Venti and Wise and of Feinstein and McFadden, limited demand may explain the absence of a market for reverse annuity mortgages.(This abstract was borrowed from another version of this item.)

But They Don't Want to Reduce Housing Equity

We have described the relationship between family attributes and moving, and between moving and change in housing wealth. Moving is often associated with retirement and with precipitating shocks like the death of a spouse or by other changes in marital status. Median housing wealth increases as the elderly age. Even when the elderly move, housing equity is as likely to increase as to decrease. Thus, the typical mover is not liquidity constrained, although some are. High transaction cost associated with moving is apparently not the cause for the lack of the reduction in housing wealth as the elderly age. The absence of a well-developed market for reverse mortgages may be explained by a lack of demand for these financial instruments. The evidence suggests that the typical elderly family does not wish to reduce housing wealth to increase current consumption. For whatever reason, there is apparently a considerable attachment among homeowners to past housing.

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Aging, Moving, and Housing Wealth

The vast majority of Individual Retirement Account contributions represent net new saving, based on evidence from the quarterly Consumer Expenditure Surveys (CES). The results are based on analysis of the relationship between IRA contributions and other financial asset saving. The data show almost no substitution of IRAs for other saving. While the core of the paper is based on cross-section analysis, important use is made of the CES panel of independent cross-sections that span the period during which IRAs were introduced. Estimates for the post 1982 period, when IRAs were available to all employees, are based on a flexible constrained optimization model, with the IRA limit the principle constraint. The implications of this model for saving in the absence of the IRA option match very closely the actual non-IRA financial asset saving behavior prior to 1982. IRA saving does not show up as other financial asset saving in the pre-IRA period.

Steven F. Venti

Papers

How Retirement Saving Programs Increase Saving

Do 401(k) contributions crowd out other personal saving

But They Don't Want to Reduce Housing Equity

Aging, Moving, and Housing Wealth

Have IRAs Increased U.S. Saving?: Evidence from Consumer Expenditure Surveys