Susan purchases a new luxury vehicle every two years and takes expensive annual vacations. She has a reputation for paying the entire bill at the upscale restaurants where she dines regularly with her friends. Susan’s annual consumption, options trading, and housing expenditures are paid for entirely out of her salary income and half of her modest annual bonus. She deposits the other half of her annual bonus and any other non-salary sources of income into her relatively small retirement account, which excludes her options trading. Susan is reluctant to incur debt and has only a small mortgage on her home, despite the fact that she will soon be made a partner in her firm and will have much higher earnings. Murray believes that Susan exhibits behavioral biases that interfere with an optimal savings and consumption allocation. In particular, he thinks that she is not saving enough for retirement. A. Discuss how Susan’s behavior reflects the bias of mental accounting. [15]
B. Explain how a rational economic individual in traditional finance would behave differently with respect to the bias. [15]