The CEPR Fifth European Workshop on Household Finance: Summary
The CEPR Fifth European Workshop on Household Finance
May 7-9, 2020
By Cristian Badarinza, NUS
On 7-9 May 2020, the Swedish House of Finance hosted the 2020 edition of the European Workshop on Household Finance. It was organised by the CEPR Network on Household Finance, together with the Swedish House of Finance, the Einaudi Institute for Economics and Finance, and the Think Forward Initiative. Due to the global imposition of various lockdown measures in response to the outbreak of the Covid-19 pandemic, the conference was held as an online webinar.
The CEPR Network runs the European Workshop on Household Finance in the spring of each year since 2016, alongside a Conference in autumn since 2015. The typical volume of submissions to the workshop is about 150 papers, with an acceptance rate of about 8%. During each year’s conference and workshop, the Think Forward Initiative and CEPR organise a discussion around issues of topical interest and this edition’s event discussed how selected “big data” -- the mass of information collected and stored through technology -- could contribute to improving household welfare. The summary of the most recent discussion can be found here.
This summary presents the main themes that emerged from papers presented at the conference.
Household Preferences and Beliefs
A two-decades long literature has documented numerous financial mistakes of households in the process of managing cash inflows and outflows, as well as assets and liabilities over the course of their life cycle. However, understanding the drivers of these mistakes requires deep insights into the preferences and beliefs of individual decision makers, structural modeling of the precise institutional setup that households act in, and high-quality data on information sets and material actions. Liu, Peng, Xiong and Xiong (2020) propose a data-driven solution to overcome these challenges, validating self-reported preferences and beliefs against the investors’ actual investment behaviour in the field. Using data from a randomized survey on the Shenzen Stock Exchange, the authors attribute the excessive trading observed in the market to a combination of the investors’ overconfidence in their ability to obtain an information advantage, and a preference for gambling. Alternative mechanisms such as the neglect of trading cost, low financial literacy, and herding phenomena due to social interaction are not supported by the data. Bonaparte, Cooper and Sha (2020) approach the same issue from a theoretical side. In a dynamic optimization framework, they show that the observed trading patterns can be reconciled with the rational behavior of optimizing agents, when explicitly accounting for the nature of the information that households have access to. Meeuwis (2020) uses a similar theoretical framework to shed light on the degree to which risk preferences vary across different life circumstances. Combining structural estimation with an identification procedure which exploits the timing of income shocks, the results suggest that permanent income growth leads to an average decrease in risk aversion, and a higher propensity to invest in public equity. In an environment of rising income inequality, this mechanism has the potential to explain the sustained polarization of wealth, alongside a decrease of risk premia in public equity markets.
Improving Financial Outcomes
Does the provision of financial advice live up to the expectation of undoing behavioural biases, correcting household mistakes and improving financial outcomes? So far, the evidence in the literature is mixed. Bucher-Koenen, Hackethal, Koenen, Laudenbach, and Weber (2020) find that advisors tailor their advice according to the gender of their client. Men generally receive recommendations to invest in more risky products, but they are also offered more significant rebates. On average, women end up with the costlier option. The authors attribute this effect to the strategic reaction of advisors which face an imperfect signal extraction problem in terms of the financial literacy of their clients and the likelihood that the recommendation will be followed through. Kulkarni, Truffa and Iberti (2020) compare the effectiveness of two different tools aimed at improving the adequacy of product choice in the credit market and decreasing rates of delinquency: (i) improved and more transparent disclosure of essential contract terms, and (ii) an emphasis on standardization of products. Exploiting two policy changes in Chile, the authors find that sophisticated borrowers benefit predominantly from improved disclosure, because they are able to process the information and end up making more informed decisions. But less sophisticated borrowers benefit more from the standardization of contracts, which removes problematic loan features entirely.
Household Decisions at a Time of Stress
Irrespective of which part of the world they call home, households have recently experienced financial stress which seemed unimaginable at the turn of the century. We are just starting to understand the consequences of these developments for individuals and societies. Gyöngyösi and Verner (2020) find that increased financial distress resulting from risky lending affects not only the real economy, but can also influence political outcomes. Building upon an empirical identification method which exploits variation in exposure to foreign currency household loans during a currency crisis in Hungary, the authors find that, in the immediate aftermath of a financial crisis, foreign currency debt exposure leads to a large and persistent increase in the far-right vote share and supports the emergence of populist movements. More generally, the results support the idea that the conflict between corporate creditors and household debtors is an important determinant of electoral outcomes. Kim, Mastrogiacomo, Hochguertel and Bloemen (2020) show that during times of economic stress, households use radical choices such as changes in household composition in order to relieve the financial burden on the household. In particular, in the Dutch context, where qualifying homeowners can buy into a mortgage guarantee scheme which insures against borrower default, the authors find that prospective losses on the housing market induce moral hazard in the form of divorce.
The Role of Financial Technology
Over the decade following the 2008 financial crisis, numerous policies have been rolled out, aimed at restricting the circumstances under which individuals obtain non-standard forms of credit (which are often short-term and unsecured), and acknowledging the possibility that choices to take such loans are imperfect. Carvalho, Olafsson and Silverman (2019) note that advocates of regulation see short-term credit as exploiting unsophisticated individuals, while opponents of the regulation see this form of credit as serving those who are in acute need of liquidity and unable to obtain it through other means. The authors address this dilemma empirically by combining high-quality administrative and experimental data from Iceland. Their results suggest that the demand for short-term high-cost credit (such as e.g. payday loans) is indeed associated with borrowers which have no better credit available through alternative market sources at the time they take the loan. However, the data also support the hypothesis that high-cost borrowers are prone to imperfect choices, with the disbursed loan amounts disproportionately spent on inessential items such as alcohol, meals out, entertainment, and gambling. Financial education targeting the households’ decision-making ability in the face of financial shocks bears the promise of better equipping consumers to avoid the harms from mistakenly choosing to take a high-cost loan, and helping them avoid “mistakes” while still allowing liquidity to reach those who need it most.
In parallel to the role of regulation, the hope is that the market discipline spurred by innovation in financial technology contributes to a more efficient and resilient financial intermediation process for households around the world. Higgins (2020) exploits a natural experiment that caused a significant disruption in the market for debit cards in Mexico, and finds that government policy which is targeting product adoption on one side of the market can lead to dynamic, market-driven spillovers across the entire ecosystem of retail firms. He concludes that financial technologies have strong direct effects on consumers who adopt them, but their ultimately positive social impact is materially determined by the ways in which he supply side of the market responds, and how this supply-side response ultimately feeds back to the demand side, through a system of indirect network externalities.