The Science of Economics

John Ledyard is an economist, but when he talks about the work that he and his colleagues who study socioeconomic systems at Caltech have completed over the last decade with the support of the Gordon and Betty Moore Foundation, he looks to astronomy for an appropriate metaphor. He’s trying to find a way to explain the importance and utility of a suite of software they have developed.

“It’s kind of like building a new, powerful telescope,” Ledyard says. “It’s not that all of the astronomers using that telescope are working on the same thing, but because of the larger telescope, they can all do a lot more, different work. What the Moore Foundation grant enabled us to do was to build a bigger measurement device.”

The new software, along with funding, has enabled researchers to create and run experiments in the lab to test all sorts of market systems involving social interactions—everything from the effect of inequality on tax rates to the best way for the United Nations to auction off pallets of natural rubber in Vietnam.

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Financial Fumbles

As football season starts up again this fall, it’s easy to become envious of football players and their multimillion dollar contracts. But don’t let the mansions and expensive cars fool you: they’re just as likely to go bankrupt as the rest of us, a recent Caltech study says.

In economics, there is a well-known model called the lifecycle hypothesis that describes how people earn, spend, and save money over the course of their lifetimes. The average person’s financial profile generally fits this model: when you’re young, you don’t earn a lot, but you need to beef up your savings for retirement; middle age is when you begin to hit your top earning potential; and when you’re retired, your income is reduced, and you need to start relying on savings.

Economist Colin Camerer and former graduate student Kyle Carlson (PhD ’15) wanted to see if this model held strong even in unusual cases—such as with NFL players who can earn millions of dollars right after college but then be forced into retirement by injuries in their mid-20s.

They collected NFL players’ publicly available football income data and tracked actual bankruptcies of those players. What they found was that although optimal models say that NFL players should theoretically earn enough money in a few years to last them through retirement, in actuality, the players go bankrupt at the same rate as the average person who earns much less. And a player’s career earnings and time in the league had no effect on this bankruptcy risk.

“We know that the hypothesis doesn’t work for these people, but we can’t really say why. There are a lot of ways in which the players are different from typical people,” Carlson says. For example, these athletes are earning large sums of money when they are very young and might be inexperienced in financial planning. Furthermore, their risk-taking behavior on the field may also result in riskier investment decisions in life. So while your favorite player may not fumble on the field, he might drop the ball when it comes to planning for his financial future. —JSC