Research on the responses to innovations in policy and technology, as well as the ways in which households make surprising or seemingly irrational financial decisions, was presented on 6 and 7 October at the 2017 CEPR European Conference on Household Finance, sponsored by the Think Forward Initiative (TFI). This column provides a short summary of the papers from the conference.
Day one: Unintended consequences, risk and retirement
The unintended consequences of policy were the focus of the first two papers.
In “A Harming Hand”, Schwartz (2017) challenged the rosy view of returns to higher education as funded by student loans. His model uses US Department of Education data to predict that, in an environment in which all student loans are issued at the same rate (so students cannot use rate information to learn their type), 30% of undergraduates should expect to realise a negative financial return on their investment in higher education. The paper concludes that, although lending at a single rate may be socially optimal, it can still encourage predatory lending.
Korgaonkar (2017) focused on “The Limited Benefits of Mortgage Renegotiation” as encouraged by regulators following the housing crisis in the US. The author found that efforts to encourage renegotiation helped borrowers who were about to default – they achieved higher credit scores and a $115 increase in monthly consumption. But the policy led to longer debt overhang for investors. Compared to foreclosing, they recovered an average of only 2.4% more of the principal balance outstanding at the time of delinquency, but with large variation (an 11.8% standard deviation).
Gorbachev and Luengo-Prado (2017) examined the counter-intuitive behaviour of some individuals who hold low-return assets while at the same time revolve high-interest credit card debt. Using the National Longitudinal Survey of Youth, the authors found that some borrower-savers are acting this way for precautionary reasons, especially when they perceive a higher risk of future credit access. Changes in perceived credit risk, in addition to preferences for risk taking, time discounting, and the composition of household balance sheets, predict transitions into and out of the borrower-saver group.
Galvez (2017) has also investigated household attitudes to risk in “Household portfolio choices and nonlinear income risk” by considering the impact of nonlinear earnings dynamics on household investment decisions in the stock market. Previous literature has found little effect, but has considered restrictive specifications that do not capture the asymmetric features in household earnings. The paper finds that differences in income uncertainty drive stock market participation and portfolio choice behaviour across households; in particular, large positive income shocks that correspond to favourable labour market events (such as job promotions) result in young, low-income, low-wealth households entering the stock market.
In the afternoon, papers discussed investments in mortgages and the impact of retirement.
In “Responses to Saving Commitments”, Andersen et al. (2017) studied how Danes responded to successfully paying off their mortgages in the period between 1995 and 2014. The authors treated the mortgage run-off as a natural experiment to study how households respond when a saving constraint is eased. They found that householders do not tend to use the income for bank deposits, stocks, or bonds. But those without large assets or debts use the resources freed up to decrease labour income, and those who are debtors use the freed-up income one-for-one to pay down debts.
Olafsson and Pagel (2017) investigated “The Retirement-Consumption Puzzle: a longitudinal study” using transaction-level data from a financial aggregation software provider. The study supported previous findings that, on retirement, individuals do not dissave as life-cycle models predict. Instead, they spent less on sports, activities and fine dining and increased liquid savings. The authors suggest that retirement causes a reassessment of household consumption habits.
Finally on the first day, De Stefani (2017) explored the Waves of Optimism that lead to biased expectations of house prices, finding that US households have house-price expectations that are over-optimistic in good times and over-pessimistic in bad ones. These biased expectations have consequences for their decision-making and investment in property: in the sample, one standard deviation increase in house price expectations changed the average leverage ratios on mortgages by 6% of a standard deviation.
Day two: Fintech, debt and surprising decisions
Fintech tools were the topic of two papers.
D'Acunto et al. (2017a) discussed “The Promises and Pitfalls of Robo-advising”, specifically whether a fintech robo-advising tool allowed investors to increase diversity in portfolios and avoid biases. On one hand, the robo-advising tool increased portfolio diversification and returns for those that held less than five stocks before adoption. But it also reduced diversification and increased fees, but not returns, for those investors that held more than 50 stocks before adoption.
Becker (2017) asked “Does FinTech Affect Household Saving Behavior?” Using data from 65,000 customers of a large European bank, he found the effect of a money management fintech service caused customers to start first-time saving and significantly increase their saving balances.
In “Salient Price Changes, Inflation Expectations, and Household Behavior”, D'Acunto et al. (2017b) used evidence from the AC Nielsen Consumer Panel to argue that the salience of price changes that individuals observe while shopping shapes their inflation expectations. These salient price changes help explain the gender differences in inflation expectations and also predict individuals’ consumption and investment behaviour.
In their paper, “Import Competition and Household Debt”, Barrot et al. (2017) argued that, in the US between 2000 and 2007, these phenomena of increased competition from imports and increased household debt levels were linked through the impact of import competition on labour markets. They used consumer credit records to show that, in this period, a one standard deviation increase in exposure to import competition explained 30% of the cross-regional variation in household leverage growth.
Finally, two papers attempted to explain surprising examples of household financial decision-making.
Gathergood et al. (2017) linked data from five major credit card issuers to ask “How Do Individuals Repay Their Debt?” They discovered that borrowers do not allocate their monthly credit card repayments to the highest interest rate card that they hold, which would minimise the cost of their borrowing. Instead, households employed a 'balance matching' heuristic, in which the share of repayments was matched to the share of balances on each card. This rule of thumb captures more than half of the predictable variation in credit card repayments.
Damar et al. (2017) examined how an increase deposit insurance may actually increase a household's exposure to risk in “The Run from Safety”. Because an increase in deposit insurance exogenously increases the share of safe assets in the household portfolio, by protecting a larger share of the household's bank deposits, households that target a fixed proportion of risky assets may respond by drawing down those safe deposits and using the cash to increase exposure to risky stocks. In Canadian data, this was precisely what occurred.
Andersen, S, P d'Astous, J Martinez- Correa, and S H Shore (2017), “Responses to Saving Commitments: Evidence from Mortgage Run-offs”. Paper presented at the 2017 CEPR European Conference on Household Finance.
Barrot, J-N, E Loualiche, M Plosser, and J Sauvagnat (2017), “Import Competition and Household Debt”. Paper presented at the 2017 CEPR European Conference on Household Finance.
Becker, G (2017), “Does FinTech Affect Household Saving Behavior? Findings from a Natural Field Experiment”. Paper presented at the 2017 CEPR European Conference on Household Finance.
D'Acunto, F, N Prabhala and A Rossi (2017a), “The Promises and Pitfalls of Robo-advising”. Paper presented at the 2017 CEPR European Conference on Household Finance.
D'Acunto, F, U Malmendier, J Ospina and M Weber (2017b), “Salient Price Changes, Inflation Expectations, and Household Behavior”. Paper presented at the 2017 CEPR European Conference on Household Finance.
Damar, H E, R Gropp and A Mordel (2017), “The Run from Safety: How a Change to the Deposit Insurance Limit Affects Households’ Portfolio Allocation”. Paper presented at the 2017 CEPR European Conference on Household Finance.
De Stefani, A (2017), “Waves of Optimism: House Price History, Biased Expectations and Credit Cycles”. Paper presented at the 2017 CEPR European Conference on Household Finance.
Galvez, J (2017), “Household portfolio choices and nonlinear income risk”. Paper presented at the 2017 CEPR European Conference on Household Finance.
Gathergood, J, N Mahoney, N Stewart and J Weber (2017), “How Do Individuals Repay Their Debt? The Balance-Matching Heuristic”. Paper presented at the 2017 CEPR European Conference on Household Finance.
Gorbachev, O and M J Luengo-Prado (2017), “The Credit Card Debt Puzzle: The Role of Preferences, Credit Access Risk, and Financial Literacy”. Paper presented at the 2017 CEPR European Conference on Household Finance.
Korgaonkar, S (2017), “The Limited Benefits of Mortgage Renegotiation”. Paper presented at the 2017 CEPR European Conference on Household Finance.
Olafsson, A and M Pagel (2017), “The Retirement-Consumption Puzzle: New Evidence on Individual Spending and Financial Structure”. Paper presented at the 2017 CEPR European Conference on Household Finance.
Schwartz, A (2017), “A Harming Hand: The Predatory Implications of Government Backed Student Loans”. Paper presented at the 2017 CEPR European Conference on Household Finance.