The CEPR Eighth European Workshop on Household Finance: Summary
April 19-22, 2023
By Cristian Badarinza (NUS and CEPR)
The CEPR Eighth European Workshop on Household Finance, co-organized with Monash Business School and held with the support of the PhD programme at EDHEC, London Business School, and Queen Mary University of London, took place in Melbourne, Australia, between 19 and 22 April 2023. The local organizer of the event was Kaveh Majlesi (Monash University and CEPR).
The event was launched on Wednesday 19 April 2023 with a Policy Event on “Pension Investment: Innovation, Challenges, and Regulation”, chaired by Sebastien Betermier (McGill University - Desautels Faculty of Management). Hazel Bateman (Professor at the School of Risk & Actuarial Studies, UNSW), Jeremy Duffield (Chairman and Co-Founder at SuperEd) and Deborah Ralston (Member of the Reserve Bank of Australia Payments System Board) were the members of the discussion panel. This summary describes the main themes emerging from the research papers presented at the academic workshop, which started on Thursday 20 April.
Behavioural drivers of financial decisions
The limited ability to acquire and process information is an inherent component of individual decision making. Over the recent years, an increasing volume of evidence highlights the link between belief formation and potential sub-optimal behaviour at household level. Andersen, Dimmock, Meisner-Nielsen and Peijnenburg (2023) contribute to this emerging literature by designing and implementing an incentivized forecasting experiment to measure forecast bias at the individual level. In this experiment, subjects are found to exhibit a tendency to excessively project recent experiences in the same direction on average, but interestingly, a large minority exhibit a bias that goes in the opposite direction – a “contrarian bias”. Quantitatively, this behavioural anomaly is strongly linked to the past history of price changes, with a one standard deviation increase in forecast bias associated with purchasing stocks with 5.7 percentage points higher excess return over the prior year, but it is not associated with superior future performance of the individual portfolio.
Girshina, Bach and Sodini (2021) confirm previous findings from the literature that women’s realized housing market returns are lower than men’s but provide evidence against the explanation that women are unwilling to bargain hard when engaged in bilateral negotiations. Instead, using a combination of a repeat-sales approach on apartments and administrative data from Sweden, they show that especially single women are less likely to participate in the professional real estate market, they have less construction-related experience than single men, and undertake fewer renovations. As a consequence, the lower listing price that women advertise on average reflects lower investment in renovations and is overall unlikely to be associated with lower bargaining power.
Mueller, Pan and Schwarz (2023) exploit data on Twitter activity by 3.7 million users, combined with geographically aggregated information about stock ownership from the IRS, and opinions on investing from Gallup polls. They find that social media activity as proxied by Twitter usage is highly influential in boosting stock market participation, with an estimated direct impact elasticity of approximately 0.5. Interestingly, the effects are not symmetrically distributed in the population, and tend to be more prevalent for young adults and minority groups. The primary mechanism that drives these results is the role of social media for information acquisition and belief formation, with higher Twitter usage being robustly associated with higher trust in stocks, and a relative re-balancing of household portfolios away from physical assets and durable goods.
Consequences of the shift in monetary policy regime
For an individual decision to be optimal, it does not only have to be consistent with individual preferences and constraints, but to reflect and adapt to the prevailing macroeconomic environment. Betermier, Calvet and Kvaerner (2022) start from the observation that, alongside deposit rates falling sharply, holdings of liquid assets have become a smaller share of financial wealth. They use administrative data from Norway and the Netherlands and show that this result is in fact driven by individuals and firms in the top 10% of the distribution of financial wealth. Most firms and individuals use cash for daily financial management, so their cash share remains insensitive to changes in interest rates and investment opportunities. In a striking contrast, the wealthiest hold elastic shares of liquid assets and respond positively to interest rates, which puts them at the center of the transmission channel of monetary policy. This suggests important interaction effects between monetary policy, aggregate risk-taking, and wealth inequality dynamics.
Leombroni and Rogers (2021) introduce a heterogeneous-household life-cycle model with multiple assets and combine it with an incomplete markets asset-pricing framework to understand the role of the household portfolio rebalancing channel for the aggregate and redistributive effects of monetary policy. A calibrated version of the model suggests that, in response to a reduction in safe asset supply that occurs after quantitative-easing policies, households rebalance portfolios towards riskier assets, which increases asset prices and, indirectly, the nominal value of household wealth. This positive wealth-effect increases the consumption response for all cohorts: it strengthens the positive consumption response of the young, and more than offsets the reduction in consumption of the old.
Wealth accumulation over the life cycle
This distinction between decisions taken by different cohorts and at different stages of their life cycle is important to understand the long-term accumulation of wealth. An and Sachdeva (2022) use custom-designed survey data and provide robust evidence that employees underestimate their future labor participation and are generally too optimistic when forming retirement expectations, which harms their financial planning and leads to under-saving for retirement. A calibrated life cycle model that incorporates expectations of retirement supports the conclusion that such errors in expectations lead to a significant reduction in overall wealth amounting to 4% over the lifetime, with the negative effects predominantly felt at the retirement stage.
Chun (2023) uses a structural life-cycle model calibrated to the Korean economy, to explore the long-term impact of the Earned Income Tax Credit on household income and welfare. Through the marginal future public pension benefits of labor supply, the labor supply response to the Earned Income Tax Credit during the working age is found to raise pension income in retirement, which amplifies the previously documented labor supply and earnings responses. Quantitatively, the paper shows that that the return accrued through the contribution-benefit link can explain half of the increase in lifetime income and one-fifth of the increase in welfare associated with the Earned Income Tax Credit. Building on this evidence, the author strongly argues in favour of policy interventions that emphasize the availability and accessibility of information about the contribution-benefit link.
Product complexity
Despite the rapid advances of communication and information technology over the past decades, individual decisions are still fraught with uncertainty about even the most basic rights and obligations that they entail. While most features of financial products are reasonably transparent, product complexity can become a serious stumbling block for most households, at different stages of their life cycle. Brown, Grodzicki and Medina (2022) exploit provisions of Title 3 in the US Credit Card Accountability Responsibility and Disclosure Act of 2009 (CARD) which reduced credit card use by college students and estimate associated welfare changes. The authors document the prevalence and form of sub-optimal financial decision-making among students and link this to their decision to borrow on a credit card. Students are found to not only benefit from the provisions of the CARD Act financially, but also in terms of increased grade-point-averages and the probability of program graduation.
Vokata (2023) studies yield enhancement products (YEPs), which are characterized by two saliently advertised rates: the headline return and the downside protection level. Issuers are found to add non-standard conditions to artificially increase both rates artificially through variations in characteristics that are largely irrelevant for both expected and realized returns. But interestingly, the demand elasticity with respect to such characteristics is estimated to be large, and this ultimately leads to a welfare cost to consumers that can be as high as $1 billion in fees over a sample period that covers the years 2006 to 2015.
Bu, Liao, Linnenluecke and Smith (2023) use data from a custom-designed field experiment with 11,261 loan-level observations obtained from a Chinese microloan company. The authors explore how personal carbon footprints can be used in consumer credit scoring and conclude that this information can help complement conventional credit information in predicting personal creditworthiness. This potentially results in economic benefits for both lenders and borrowers by (i) increasing credit access for the unbanked part of the population, as well as (ii) a reduction in the consumer-level carbon footprint.
Long-term assets
In addition to the short-term allocation of cash flows between consumption, saving and investment, households have the often very difficult task of allocating resources to entrepreneurial business projects, that require an immediate large-scale deployment of capital, but can only be expected to deliver returns in the medium- to long run. To gain more insight into household optimization along this dimension, Li (2021) develops a novel measure of bank discrimination based on the narrative information extracted from the complaints filed to the Consumer Financial Protection Bureau (CFPB) using textual analysis. Relaxed financial constraints, that arise through the interstate bank deregulation from 1994 to 2021, are found to reduce the gender and racial gaps in startup performance, and to provide more equal access to entrepreneurial opportunities.
Finally, the issue of how individuals make their location decisions and how this affects welfare is a question into which many economists and policy makers seek to gain insights, but due to limited data availability, definitive answers remain elusive. Giannone, Paixao, Pang and Li (2023) introduce a novel quantitative dynamic location model to feature sorting of agents across locations based on their assets, age and home-ownership status. The authors apply the model to the data by calibrating it to 28 Canadian cities and validate theoretical predictions about the distribution of net worth and migration decisions in the data. Through the lens of the model, counterfactual simulations show that a 10% subsidy in moving, if disbursed in utility terms, would increase the migration rates by almost 50% and induce a lower share of movers to move to “opportunity". In addition, a decrease in housing regulation in supply-constrained locations such as Vancouver can increase welfare by approximately 5%, and by 0.57% in Canada overall.
