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Self Control and Liquidity: How to Design a Commitment Contract

Publication Date:
Jan 2011
Project Programs:
Behavioral Economics
Consumer Finance Working Group

If individuals have self-control problems that lead them to spend money when they had previously planned to save it, they may take up financial commitment devices that restrict their future ability to access their funds. We experimentally investigate how the demand for commitment contracts is affected by contract design features. In our experiments, each subject is endowed with a sum of money and asked to divide that money between a liquid account, which permits unrestricted withdrawals at any time over the course of the months-long experiment, and one or more commitment accounts, which impose withdrawal penalties or restrictions. The design features of the liquid account are the same for all subjects, but the design features of the commitment account(s) are randomized across subjects. When the interest rates on the two types of accounts are the same, we find that allocations to a commitment account are higher when the account is less liquid. The commitment account that disallows early withdrawals altogether attracts the largest allocations. However, this relationship no longer holds when the commitment account interest rate is greater than the liquid account interest rate.

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Journal of the Social Sciences

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