Staff Report 367

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Temptation and Self-Control: Some Evidence and Applications

Kevin X. D. Huang
Zheng Liu
Qi Zhu

Published January 1, 2006

Abstract
This paper studies the empirical relevance of temptation and self-control using household-level data from the Consumer Expenditure Survey. We estimate an infinite-horizon consumption-savings model that allows, but does not require, temptation and self-control in preferences. To help identify the presence of temptation, we exploit an implication of the theory that a tempted individual has a preference for commitment. In the presence of temptation, the cross-sectional distribution of the wealth-consumption ratio, in addition to that of consumption growth, becomes a determinant of the asset-pricing kernel, and the importance of this additional pricing factor depends on the strength of temptation. The estimates that we obtain provide statistical evidence supporting the presence of temptation. Based on our estimates, we explore some quantitative implications of this class of preferences on equity premium and on the welfare cost of business cycles.


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