Self Control and Liquidity: How to Design a Commitment Contract

Abstract:

If individuals have self - control problems that lead them to spend money that they had previously planned to save, they may take up commitment contracts that restrict their spending . We experimentally investigate how the demand for commitment contracts is affected by contract design. Each experimental subject receives an endowment of money and divides that money between a liquid account, which permits unrestricted withdrawals, and a commitment account, which imposes a penalty on early withdrawals. The features of the liquid account are the same for all subjects, but the features of the commitment account are randomized across subjects. The commitment account that disallows early withdrawals — the most illiquid commitment account — attracts more money than any other commitment account. We extend the theoretical work of Amador, Werning, and Angeletos (2006) to show that the pattern of experimental commitment account allocations arises in a leading model of intertemporal choice under natural assumptions.