To save or to gamble: How Prize Linked Savings could help you do both Why is the savings rate in the

U.S. so low? It could be because people do not have the money to save. Or, maybe the low interest rates (and subsequent low returns on investment) discourage saving. Dr. Erkut Ozbay, economics professor at the University of Maryland, along with professors Emel Filiz-Ozbay, University of Maryland, Jonathan Guryan, Northwestern University, Kyle Hyndman, Maastricht University, Netherlands, and Melissa Kearney, University of Maryland, has been conducting research as to why people are not saving and what can be done to encourage saving. We found that the lower income group gambles, Dr. Ozbay said. They have some money to save but would rather try to win big in the lottery since the interest rates in banks are so low. By gambling in this manner, people are spending money on tickets, with the odds of winning being one in 175 million. In this respect, people are highly unlikely to earn the money back. Dr. Ozbay and his co-authors developed the concept of Prize Linked Savings in response to this phenomenon. The concept of a Prize Linked Savings account is to add a stochastic element to an otherwise standard account, such that depositors periodically receive a chance to win a specified (and potentially large) prize that is a function of deposit amounts, explained the authors.! By changing the system and introducing a lottery component to saving, perhaps people will save more. England used this model in the 1950s to encourage saving as well, according to Dr. Ozbay.!

Dr. Ozbay and his co-authors conducted their study on 96 University of Maryland students. They aimed to discover whether savings behavior responds more to a chance of winning a lottery, or to guaranteed interest payments of the same expected value. The decision for a participant to be part of the lottery or receive the interest payments also needed to be measured against the degrees of risk or uncertainty in winning the bank lottery. Instead of paying everyone that small amount of interest, the bank will pay the lump sum to one winner, Dr. Ozbay said. Therefore, adopting Prize Linked Saving will not cost the bank any money because it would have been paying out that money regardless. Dr. Ozbay and his co-authors found that when presented with the opportunity to earn a larger amount of money, even participants who never gambled answered that they would be more willing to save. Banks have already approached the authors to discuss the possibility of implementation. Not only could Prize Linked Savings be applied to banks, but it could also be used for tax agencies. Instead of receiving your tax return right away, the agency could hold that money for you thus entering you into a lottery in which you can make back much more than the interest. Legal barriers to the offering of Prize linked savings products in the U.S. are becoming less binding, which hopefully will lead to fruitful opportunities to offer such products as part of a research demonstration, wrote the authors.

To read the full study, Do Lottery Payments Induce Savings Behavior: Evidence from the Lab, click here.