How much does financial illiteracy cost households and society? How best should policymakers regulate borrowing? How do social networks and biases affect household investment, and can policy overcome their negative effects? These are among the questions that were discussed on 28-29 April 2017 at the Copenhagen Business School, which hosted the 2017 CEPR European workshop on household finance, co-sponsored by Think Forward Initiative (TFI, http://www.thinkforwardinitiative.com/).
Delegates shared state-of-the-art empirical and theoretical research on household financial behaviour and on how it is influenced by other choices, government policies, and the overall economic environment. The programme was divided into six sessions over the two days.
The CEPR Network on Household Finance aims to promote research on household finance that combines scientific excellence and relevance to policymakers. It also promotes young researchers, so the workshop combines presentations by established researchers and doctoral students in household finance. The network fully funds conference attendance by a number of PhD students in addition to student speakers and has now established a best student paper award, sponsored by TFI. The first award was made to Matteo Benetton, PhD student at the London School of Economics, for his single-authored paper on “Competition and macro-prudential regulation: An empirical model of the UK mortgage supermarket”.
Day one: Mortgage advice, repayment delinquency and gender effects in investment
Session one covered mortgage markets. Guiso et al. (2017) present a model of the Italian mortgage advice market, divided between sophisticated and naive borrowers, which when matched with empirical data implies that the cost of distorted financial advice is equivalent to increasing the annual mortgage payment by €1,177 euro, with both naive and sophisticated households suffering. Benetton (2017) studies the effect of macro-prudential regulation on lending activity in the UK mortgage market. He finds that a 1% increase in the interest rate decreases loan demand by 2% and product demand by 3%, on average, and that a 1% higher risk-weights increase the marginal cost of lending by approximately 1%. Session two, focusing on household wealth, maintained the theme with a paper by DeFusco et al. (2017) quantifying the surprising effects of the Dodd-Frank 'Ability-to-Repay' rule on the US mortgage market. The rule reduced the incentives to originate loans to high-leverage borrowers. While this raised the price of these loans moderately, it caused a surprisingly large fraction of lenders to ration credit, eliminating 15% of the affected loan market and reducing leverage on 20% of other loans. However, despite these large effects on quantities, the policy ultimately would have had only little impact on default rates in the crisis. Garbinti, Goupille-Lebret and Piketty (2016) study the long-term evolutions and the determinants of wealth equality in France over the 1800-2014 period. They highlight the importance of three key factors to understand wealth inequality dynamics: unequal saving rates, unequal rates of return and unequal labour earnings.
Session three turned to financial decision-making in the household. Exler (2017) considers whether and how to regulate 'small dollar' lending in the US, specifically the problem of how to deal with escalating repayments and late fees when the loans are delinquent. This problem has prompted the Consumer Financial Protection Bureau to propose a repayment plan allowing affected households to repay their debt in three instalments. Exler's model finds this does not yield any welfare gains, although a policy by which the upfront costs of bankruptcy can be deferred until after the debt has been forgiven increases both household and aggregate welfare. In the second presentation, Ke (2017) investigates whether gender norms shape household financial decisions. The findings suggest that gender norms constrain women's influence over intra-household financial decision making, which can have real consequences on household financial well-being.
Day two: Lottery winners, good neighbours and correlated risks
On day two, the fourth session investigated consumption using two examples of large Scandinavian data sets. Di Maggio et al. (2017) use detailed stock holding and consumption data from Sweden and investigate how household consumption responds to changes in stock market returns. They find that, on average, the marginal propensity to consume out of capital gain is about 3% – though it varies from 5% for the lower part of the wealth distribution to about 1.5% for the top 1%. The marginal propensity to consume out of dividend payments is at least ten times as big as the one out of capital gain across wealth groups. Fagereng et al. (2015) use Norwegian data to study the effect of winning the lottery on consumption. Although this varies with size of win and liquidity of existing assets, the winner of the median lottery prize consumes more than 65% of the entire prize within one year.
In session five, on social interactions, Haliassos et al. (2017) ask: what is the impact of having financially-literate neighbours on own financial behaviour? In Sweden, their research shows, there is a positive and lasting effect, which is larger when neighbours have business or economics education and shown in both savings for retirement and stockholding. Meanwhile 'social' trading, in which investors can copy the actions of others without seeking professional advice, is a growing trend. Pelster and Romero Gonzalez (2016) show that this type of trading is susceptible to biases: trades with many followers, for example, are less likely to be closed and more likely to be increased – especially when they are losing money.
Finally, the sixth session was on financial decision-making. Fulford and Schuh (2017) show that credit utilisation – the fraction of the available credit card limit used – is stable over the business cycle, the life-cycle, and for individuals in the short term. They propose a model in which credit cards have both a precautionary and payments value, and estimate the preferences necessary to match observed life-cycle debt and consumption. Laudenbach et al. (2017) study the problem that households tend to ignore correlation of risk among their investments, using laboratory experiments. They find that using a graphical sampling procedure to inform investors about the correlation of returns of two assets, and letting them experience the impact that correlation may have on their portfolios, may help them to diversify their risk – contrary to simply describing this correlation which has no effect.
Benetton, M (2017), "Competition and macro-prudential regulation: An empirical model of the UK mortgage supermarket", paper presented at the 2017 CEPR European Workshop on Household Finance.
DeFusco A A, S Johnson and J Mondragon (2017), "Regulating Household Leverage", paper presented at the 2017 CEPR European Workshop on Household Finance.
Di Maggio, M, A Kermani and K Majlesi (2017), "Stock Market Returns and Consumption", paper presented at the 2017 CEPR European Workshop on Household Finance.
Exler, F (2017), "Regulating Small Dollar Loans: The Role of Delinquency", paper presented at the 2017 CEPR European Workshop on Household Finance.
Fagereng, A, M B Holm and G J Natvik (2016), "MPC heterogeneity and household balance sheets", paper presented at the 2017 CEPR European Workshop on Household Finance.
Fulford, S L and S Schuh (2017), "Why is credit utilization stable? Precaution, payments, and credit cards over the business cycle and life cycle", paper presented at the 2017 CEPR European Workshop on Household Finance.
Garbinti, B, J Goupille-Lebret and T Piketty (2016), "Accounting for Wealth Inequality Dynamics: Methods, Estimates and Simulations for France (1800-2014)", WID.world Working Paper Series N° 2016/5.
Guiso, L, A Pozzi, A Tsoy, L Gambacorta and P Mistrull (2017), "Distorted Advice in Financial Markets: Evidence from the Mortgage Market", paper presented at the 2017 CEPR European Workshop on Household Finance.
Haliassos, M, T Jansson and Y Karabulut (2017), "Financial Literacy Externalities", paper presented at the 2017 CEPR European Workshop on Household Finance.
Ke, D (2017), "Who Wears the Pants? Gender Identity Norms and Intra-Household Financial Decision Making", paper presented at the 2017 CEPR European Workshop on Household Finance.
Laudenbach, C, M Ungeheuer and M Weber (2017), "How to Overcome Correlation Neglect?", paper presented at the 2017 CEPR European Workshop on Household Finance.
Pelster, M and G Romero Gonzalez (2016), "Social media interactions and biases in investment decisions", paper presented at the 2017 CEPR European Workshop on Household Finance.