The CEPR Sixth European Workshop on Household Finance: Summary
April 14-16, 2021
By Cristian Bandarinza (NUS and CEPR)
The CEPR Sixth European Workshop on Household Finance, held with the support of the Think Forward Initiative (TFI), took place online between 14 and 16 April 2021. This summary describes the main themes emerging from the papers presented at the workshop.
On 14-16 April 2021, EDHEC Business School hosted the sixth edition of the European Workshop on Household Finance. It was organised together with the CEPR Network on Household Finance, and the Think Forward Initiative. Due to the imposition of global travel restrictions in response to the Covid-19 pandemic, the workshop 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 that continues a tradition started in Athens in 2010. 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 the implications of finance for inequality, including financial tools that can help households to better manage their finances and curb inequality in asset returns and debt costs. Further information and a recording of the event, organized by Laurent Calvet, can be found below.
This summary presents the main themes that emerged from the academic papers presented at the Workshop.
The Behaviour of Retail Investors
Unlike institutional investors, which can draw upon large pools of both financial capital and analytical expertise, retail investors act under the constraints of limited, incomplete information, limited information processing capacity, and non-trivial frictions to the inter-temporal allocation of capital. To quantify the implications of sub-optimal investment behaviour on aggregate financial market outcomes, Batermier, Calvet, Knüpfer and Kvaerner (2021) track the individual stockholdings of Norwegian investors over the two decades between 1997 and 2018. Sorting stocks according to the social and demographic characteristics of the investors who own them, they find significant segmentation along the dimensions of wealth, indebtedness, age, gender, education, and investment experience, equally driven by differences in hedging motives and market sentiment. This generates a set of novel cross-sectional pricing effects on the aggregate market, and provides useful context for the interpretation of traditional factors such as size and momentum.
Cole, Parker, Schoar and Simester (2021) study middle-class investors in the United States. More than two thirds of these investors’ wealth is held in publicly traded equity during their active working lives, with participation rising modestly early in life and falling significantly as people approach retirement. Importantly, the authors report that the share of public equity in the overall household balance sheet has become less dependent on income or wealth over time – a development which can partially be attributed to a broad, secular trend, and significantly accelerating after the recent introduction of target date funds as default options in retirement saving plans.
Brandsaas (2021) places the observed high stock market exit rate of individual investors at the center of this discussion, in the context of a quantitative portfolio choice model that can match four main dimensions of household behaviour over the life-cycle (the stock market participation rate, the rate of homeownership, the conditional risky assets share, and the dynamics of net worth). The combination of per-period costs and housing tenure allows the model to match the entry and exit rates of retail investors, and to establish a causal link between the dynamics of the property market, the evolution of home equity, and the participation of individual households in the stock market.
Heimer, Iliewa, Imas and Weber (2021) provide deeper insights into a similar mechanism of decision making at individual level, which links the observed entry and exit behavior to self-control issues and emotional impulsivity. Using an experimental brokerage setup, they find that retail investors initially contextualize risk as part of a “loss-exit” strategy, planning to increase risk exposure after gains, and to decrease it after losses; but subsequent actual behavior follows the reverse pattern, with investors cutting gains early, and chasing losses. This dynamic inconsistency is partly associated with a lack of financial sophistication, which can lead to material welfare losses in the long term.
Loos, Mayer and Pagel (2021) confirm the individual propensity to sell winners and hold losers in transaction-level data on an exhaustive set of asset holdings, securities trades, spending, and income from clients of a German retail bank. They are able to partially isolate the drivers of inefficient behavior by exploiting the implementation of a capital gains tax reform that triggered an ad hoc re-calculation of capital gains taxes. This quasi-experiment generated fictitious winners (funds that are displayed as winners but are actually losers) and fictitious losers (funds that are displayed as losers but are actually winners). Investors respond more when the fictitious gain is large and the actual loss is small; and they continue to behave in this asymmetric fashion even when the information about their actual capital gains is very salient.
Household Investment in Human Capital
The household finance literature agrees on the role of higher-education attainment as a significant driver of the accumulation of human capital. However, as of yet there is little theoretical guidance on the trade-offs involved in the build-up of alternative forms of financial and non-financial wealth, and the policies which most effectively allocate the cost of education over the life cycle. Ebrahimian (2021) structurally estimates a dynamic model to quantify the role of financing frictions in explaining the unequal investment in human capital between rich and poor students. Financing frictions are found to be a significant barrier to the accumulation of human capital, but the evidence suggests that differences in higher-education attainment are primarily driven by fundamental factors such as college preparedness and heterogeneous preferences. Through a set of alternative counterfactual scenarios, the paper documents the limited potential of federal loans to alleviate financial constraints, and concludes that direct grants are a much more cost-effective policy to provide access to college for lower-income students.
Aging and Health Insurance
The global aging of the population poses numerous new challenges to the financial system, most strikingly visible in the interaction between the financing of retirement and the exposure to health shocks. Blundell, Borella, Commault and de Nardi (2021) show that income and health risks remain pervasive in old age, and even transitory income and health shocks trigger significant consumption responses. When placing these results in a structural life-cycle perspective, the results are consistent both with a financial wealth channel, and a state-dependent shift in utility, for different segments of the population: on one side, among low-wealth households, a negative income shock mainly reduces expenses on food and utilities, and a negative health shocks generates a drop in expenses on car maintenance; on the other side, among high-wealth households, both negative income and health shocks reduce expenses on leisure activities.
How does the provision of social insurance affect the saving behaviour of households? Bornstein and Indarte (2021) exploit the staggered expansions of Medicaid as a source of quasi-experimental variation in households’ access to health insurance. The evidence suggests that the provision of insurance is associated with an increased exposure to short-term unsecured debt – consistent with the structural transmission mechanism implied by a heterogeneous-agents model with permanent and transitory variation in income, unpredictable health expenditure shocks, and incomplete markets. The driving force of this result is that, in general equilibrium, insurance dampens the individual precautionary savings motive and raises the lenders’ expected returns. This simultaneously increases the demand and the supply of unsecured credit.
Mortgage Market Regulation
As global households continue to accumulate debt at a rapid pace, mortgage market regulation is slowly returning to the forefront of academic research. Cespedes, Sialm and Parra (2021) study the potential ex-post benefits of mortgage cramdown on bankruptcy filers. Exploiting the random assignment of judges and the differences in discharge rates within courts that differentially allowed principal mortgage reduction over the period between 1989 and 1993, the authors find that a successful Chapter 13 filing reduces the five-year foreclosure rate by 29 percentage points and reduces the number of moves post-bankruptcy, strongly suggesting that debt overhang considerations are an important driving force of homeowner default.
The potential benefits of regulation are further apparent in a context in which households find it difficult to engage effectively with the existing financial infrastructure. Despite the high financial stakes and the transparent UK credit market environment, Gianinazzi (2021) reports evidence for household mistakes in mortgage refinancing decisions, with borrowers inefficiently evaluating the benefits from refinancing relative to nominal reference points based on personal experience. While average refinancing rates positively correlate with proxies for financial literacy, such nominal reference point effects are found to be robust and stable in magnitude across income and age groups. When judged against a rational model of mortgage refinancing, this can impose potentially significant barriers to the pass-through of expansionary monetary policy.
