Prize-Linked Savings Games: Theory and Experiment

Abstract

We introduce a game in which each player can allocate her endowment in a prize-linked savings (PLS) account, which awards a fixed prize only to a randomly chosen winner. Like Tullock's rent-seeking contest, the probability for each player of winning the prize is the ratio of her PLS deposit to the total deposits made by all participating players. We derive a unique equilibrium and further examine the effects of introducing PLS as an alternative savings option to traditional savings (TS), which yields a fixed rate of return. Our theory predicts that, while inducing the group with low TS deposits to save more, PLS will cannibalize TS and reduce total savings in the group with high TS deposits. However, in contrast to the theory, our experimental results show that PLS significantly increases total savings in both groups.