Long-Range Financial Decision-Making: The Role of Episodic Prospection

Abstract

In this paper, we argue that time-inconsistent preferences in financial decision-making are sensitive to the kind of prospection involved. Given that episodic prospection increases the subjective importance of a future reward (Benoit, Gilbert and Burgess, 2011), we expect that this human faculty is able to reduce hyperbolic discounting biases. Furthermore, we suppose that the role of episodic prospection in reducing hyperbolic discounting may vary depending on the typology of solicited scenarios, environmental conditions and an individual’s personality traits. An experimental task was submitted to a sample of young individuals (N=77; 40 Germans and 33 Italians; average age 22 years, range 18-30), who were asked to make farsighted decisions and engage their episodic prospection. Our experimental results provide evidence of the influence of episodic prospection in human decision-making; we show that episodic prospection generates a more rational attitude in relation to decisions about the future. This was found to be particularly true if the solicited scenario referred to a primary need (a first priority). These findings suggest that the vivid representation of future events can be used to ‘nudge’, i.e. stimulate, sound long-range decision-making, with clear implications for both policy makers and the financial industry. Nevertheless, cautiousness is necessary, because we also provide evidence that personal and environmental conditions, as well as the type of domain (e.g. first priority, second priority or entertainment) being projected into the future may reduce the effect of this ‘nudge’. We also found that an extremely vivid self-projection into real-life situations can lead some people to refuse to project themselves in the ‘distant future’, thus reverting the role of episodic prospection, from a nudge into a brake on long-range decision-making.