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Financial Literacy, Present Bias and Alternative Mortgage Products

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Abstract

Choosing a mortgage is one of the most important financial decisions made by a household. Financial innovation has given rise to more complex mortgage products with back-loaded payments, known as ‘Alternative Mortgage Products’ (AMPs), or ‘Interest-Only Mortgages’. Using a specially designed question module in a representative survey of UK mortgage holders, we investigate the effect of consumer financial sophistication on the decision to choose an AMP instead of a standard repayment mortgage. We show poor financial literacy and present bias raise the likelihood of choosing an AMP. Financially literate individuals are also more likely to choose an Adjustable Rate Mortgage (ARM), suggesting they avoid paying the term premium of a fixed rate mortgage.

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... There is also a strand of literature suggesting that more literate consumers have a better understanding of differences between distinct types of mortgages and are better able to select the type that is well-fitted to their specific situation, thus reducing mortgage costs. Gathergood and Weber (2017) and Smith et al., (2012) observe that financial literacy increases the likelihood of selecting an adjustable rate mortgage (ARM) compared to a fixed rate mortgage (FRM). Gathergood and Weber (2017) interpret this finding as being indicative of more financially literate consumers being more aware of the added cost entailed by the term premium of a fixed rate mortgage. ...
... Gathergood and Weber (2017) and Smith et al., (2012) observe that financial literacy increases the likelihood of selecting an adjustable rate mortgage (ARM) compared to a fixed rate mortgage (FRM). Gathergood and Weber (2017) interpret this finding as being indicative of more financially literate consumers being more aware of the added cost entailed by the term premium of a fixed rate mortgage. Generally, such findings suggest that financially literate individuals may outperform the others in terms of their ability to scan and critically compare important features of various types of mortgage when making borrowing decisions. ...
... Fornero et al., (2011) show that financial literacy supports consumers' ability to assess their risk exposure and match the type of mortgage (ARM or FRM) to the level of exposure. Gathergood and Weber (2017) have established that less financially literate consumers tend to take out alternative mortgage products (AMPs) more often. The key feature of AMPs is a considerable reduction in upfront payments. ...
Article
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The key parameter in borrowing is the interest rate. However, research shows that many consumers have very low levels of debt literacy, including knowledge and understanding of effective interest rates. This article uses data obtained from a sample of 1,055 borrowers and a three-question debt literacy test to learn which properties of the effective interest rate notion and the calculation thereof are particularly difficult for consumers to comprehend. To this end, logistic regressions were applied which showed that, of the three aspects of the effective interest rate examined, the largest gaps in knowledge and understanding relate to the concept of the time value of money. Unlike the other two aspects, in this case knowledge gaps are more egalitarian-they affect women and men equally and they do not depend significantly on the level of education. Answers to the time value of money question are also differently related to non-cognitive factors compared to answers to the other two questions in the applied debt literacy test. Treating incorrect and "don't know" responses as separate categories in multinomial regressions confirms these observations , but also suggests that each of these two response categories may convey different informational content.
... Possessing money management skills, in the form of attention to expenses, has also been emphasized by a number of works as part of financial literacy. Money management skills are often associated with an individual's careful planning of the current financial situation, self-control, budgeting, and anticipation of bills (Ameriks et al., 2007;French & McKillop, 2016;Gathergood, 2012;Gathergood & Weber, 2017;Lea et al., 1995). ...
... Important research on financial literacy has focused on its impact on mortgage debt. A mortgage loan is the largest debt of the typical household (Gathergood & Weber, 2017). Huston (2012) finds that financially illiterate individuals tend to incur in higher cost of borrowing for mortgage loans, and Gathergood and Weber (2017) find this population to be more likely to obtain more complex and costlier mortgage products such as "interest-only" mortgages. ...
... A mortgage loan is the largest debt of the typical household (Gathergood & Weber, 2017). Huston (2012) finds that financially illiterate individuals tend to incur in higher cost of borrowing for mortgage loans, and Gathergood and Weber (2017) find this population to be more likely to obtain more complex and costlier mortgage products such as "interest-only" mortgages. Furthermore, Gerardi et al. (2010) find strong correlations between decreases in financial literacy and increases in mortgage delinquencies and defaults. ...
Article
In this paper we attempt to find existing linkages of financial literacy with indebtedness and wealth accumulation of households in Bogotá, the capital of Colombia. We analyze an econometric model where we regress a household's debt usage, cost of debt servicing, and wealth indicators against its financial literacy. Financial literacy is assessed according to the financial numeracy and money management skills of the head of households. Numeracy skills are found to have a positive correlation with the decision to use debt and have a mortgage and with the total number of lending sources, debt-to-income, and net worth. Money management skills decrease the household's likelihood of using all of the debt types considered in the analysis and increase with net worth. We also uncover important debt and wealth accumulation conducts closely tied to the city's economic stratification and the gender of the head of household. A number of public policy implications are derived from the results of the analysis.
... In practice, questionnaires are used to quantify an individual's financial literacy. In most studies, an individual is asked to answer three or four questions regarding inflation and interest rates (Choi et al., 2010;Disney and Gathergood, 2013;Gathergood et al., 2017;Gaudecker, 2015;Jappelli and Padula, 2013;Klapper et al., 2013;Lusardi and Mitchell, 2008). Exceptions are Behrman et al. (2012), which asked 12 questions, and van Rooij et al. (2012), which asked a total of 16 questions. ...
... In general, those with lower financial literacy are more likely to be elderly, female, unemployed, less healthy individuals or households (Agarwal et al., 2009;Calvet et al., 2009;Jappelli and Padula, 2013). Higher cognitive ability, manifested in higher mathematical performance during the teens or higher education attainment, is also associated with higher financial literacy (Gathergood and Weber, 2017;Jappelli, 2010;Jappelli and Padula, 2013). In addition, people with home-ownership, or higher income, higher property value, or less consumer debt are found to be more financially literate (Disney and Gathergood, 2013;Gathergood and Weber, 2017). ...
... Higher cognitive ability, manifested in higher mathematical performance during the teens or higher education attainment, is also associated with higher financial literacy (Gathergood and Weber, 2017;Jappelli, 2010;Jappelli and Padula, 2013). In addition, people with home-ownership, or higher income, higher property value, or less consumer debt are found to be more financially literate (Disney and Gathergood, 2013;Gathergood and Weber, 2017). In this current study, the empirical studies account for these demographic and socioeconomic factors as control variables in explaining an individual's financial literacy. ...
Article
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This study provides empirical evidence on the mechanisms through which financial literacy may be associated with saving for retirement, in the three phases of the decision-making process-information perception, information search and evaluation, and decision-making and implementation. The results indicate that financial literacy has significantly positive effects on one's awareness of post-retirement financial needs, comparing alternatives when purchasing financial products, displaying fewer present-time, and planning for and setting aside funds for retirement. Financial literacy not only directly contributes to planning for future, but also indirectly via a reduction in behavioral biases.
... In practice questionnaires are used to quantify an individual's financial literacy. In most studies an individual is asked to answer three or four questions regarding inflation and interest rates (Choi et al. 2010;Disney and Gathergood 2013;Gathergood et al. 2017;Gaudecker 2015;Jappelli and Padula 2013;Klapper et al. 2013;Lusardi and Mitchell 2008). Exceptions are Behrman et al. (2012) which asked 12 questions and Rooij et al. ...
... In general those with lower financial literacy are more likely to be elderly female unemployed less healthy individuals or households (Agarwal et al. 2009;Calvet et al. 2009;Jappelli and Padula 2013). Higher cognitive ability manifested in higher mathematical performance during the teens or higher education attainment is also associated with higher financial literacy (Gathergood and Weber 2017;Jappelli 2010;Jappelli and Padula 2013). In addition people with home-ownership or higher income higher property value or less consumer debt are found to be more financially literate (Disney and Gathergood 2013;Gathergood and Weber 2017). ...
... Higher cognitive ability manifested in higher mathematical performance during the teens or higher education attainment is also associated with higher financial literacy (Gathergood and Weber 2017;Jappelli 2010;Jappelli and Padula 2013). In addition people with home-ownership or higher income higher property value or less consumer debt are found to be more financially literate (Disney and Gathergood 2013;Gathergood and Weber 2017). In this current study the empirical studies account for these demographic and socioeconomic factors as control variables in explaining one's financial literacy. ...
Conference Paper
This study aims to provide empirical evidence on the mechanisms through which financial literacy may be associated with the behaviors of saving for retirement, in the three phases of decision-making process-information perception, information search and evaluation, and decision-making and implementation. Empirical results indicate that, after accounting for various control variables, financial literacy has significantly positive effects on one's awareness of post-retirement financial needs, comparing with alternative products when making significant financial decisions, displaying less behavioral biases, planning for and successfully securing post-retirement funds, and experiencing fewer financial disputes. The results can provide explanations for the findings of previous studies as to why people with higher financial literacy accumulate greater net wealth, make wiser financial decisions, or are more likely to invest in the stock market. JEL classification: G1; G4
... First, financially literate consumers are more likely to comparison shop before selecting a mortgage, while those who are less financially literate tend to accept a mortgage offer from the first financial intermediary they applied to (Fornero et al., 2011). Second, more literate consumers have a better understanding of differences between distinct types of mortgages and are better equipped to select the type that is well-fitted to their specific situation which, in turn, limits the mortgage costs (Gathergood & Weber, 2017;Smith et al., 2012). Third, financial literacy supports consumers' ability to assess their risk exposure and match the mortgage type to the exposure (Fornero et al., 2011). ...
... Third, financial literacy supports consumers' ability to assess their risk exposure and match the mortgage type to the exposure (Fornero et al., 2011). Fourth, less financially literate consumers tend to take on high-cost alternative mortgage products (AMPs) more often (Gathergood & Weber, 2017). Finally, deficiencies in financial literacy are positively related to the incidence of delays in repaying debt and delinquency that can contribute to the total cost burden entailed by the debt (Agarwal et al., 2017;Fornero et al., 2011). ...
Article
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This study evaluated the link between financial literacy and household mortgage decisions. To this end, the longitudinal dataset for the US population from the Panel Study of Income Dynamics (PSID) was used. Evidence for links between financial literacy levels and (1) mortgage uptake, (2) mortgage interest rates, and (3) mortgage refinancing decisions were examined using the two waves (2015 and 2017) of PSID data, combined with the 2016 PSID supplementary questionnaire examining the measured financial literacy of household members. Our results revealed a positive link between financial literacy and mortgage possession and, additionally, between financial literacy and the subsequent decision to take out a mortgage. Moreover, higher financial literacy scores were associated with lower mortgage interests and a greater likelihood of mortgage refinancing. On average, a household that refinanced its mortgage was able to reduce its interest rate by almost 0.7 percentage points, providing evidence of the positive role of financial literacy in securing better mortgage terms.
... These 10 questions are related to "lifestyle design" (1 question), basic knowledge of economy and finance (5 questions), loan and credit (2 questions), and wealth management (2 questions). For computing a financial literacy measure, the current study adopts the following five questions relating to knowledge on interest rate compounding, inflation, risk diversification, bond price, and mortgage, following previous related studies (e.g., Allgood & Walstad, 2016;Asaad, 2015;Despard et al., 2020;Gathergood & Weber, 2017;Ooijen & Rooij, 2016). ...
... 6 The choices are: (1) living expenses for own lifetime, children's educational expenses, and medical expenses for self, (2) children's educational expenses, costs of buying a house, and living expenses for own retirement, (3) costs of buying a house, medical expenses for self, and costs of nursing care for parents, and (4) Don't know. 7 Other instruments for financial literacy include the mathematical ability during the teens (Gathergood and Weber, 2017;Jappelli and Padula, 2013), the experience of family members (Behrman et al., 2012;Rooij et al., 2011), or the number of universities or newspaper circulating in the neighborhood (Klapper et al., 2013). dispositions. ...
Article
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This study investigated whether overconfidence with respect to one’s financial literacy affects stock market participation and retirement preparation and if so, how. Using an effective sample of 12,653 Japanese individuals, the empirical results confirm that financial literacy plays a positive role, while confidence in financial literacy also matters. For people with relatively low financial literacy, overconfidence can encourage taking financial action, while for people with high financial literacy, underconfidence can deter action. Confidence could have an effect equal to or greater than financial literacy. Moreover, it was also found that the positive effect of overconfidence is weaker for women than for men.
... Lack of financial literacy and its causes have been discussed by academics and practitioners alike, see, e.g., Reference Bucher-Koenen and and Burke and Manz (2014). Furthermore, the effects of financial illiteracy have also been investigated in numerous studies (Bianchi 2018;Fernandes et al. 2014;Gathergood and Weber 2017;Lusardi and Mitchell 2014;Van Ooijen and van Rooij 2016;Van Rooij et al. 2011). In all these studies, the measurement of financial literacy is of central importance. ...
... In the first part, we introduce various financial literacy scales that have been proposed in literature. Of course, it would be unfeasible to include every single question that has been raised with regard to this topic in the past, but we identified eight typical and important articles in this field (Alexeev et al. 2014;Anderson et al. 2017;Bianchi 2018;Burke and Manz 2014;Ćumurović and Hyll 2019;Gathergood and Weber 2017;Lusardi and Mitchell 2011;Van Ooijen and van Rooij 2016). • ...
Article
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Financial (il-)literacy and its effects have been studied extensively in recent years. The measurement of this concept is, however, tricky and numerous measurement instruments exist. In this paper, we study the connection between these measures empirically. We find that these measures are often only slightly related and that this is a so-far overlooked empirical problem in this field. As a result of our analysis, we suggest the combination of two measures as the best potential alternative to the existing measures. Finally, we analyze the predictive power of this suggested measure for stock investment decisions.
... Even when efforts to increase financial knowledge are effective, financial knowledge explains a relatively small portion of the consumer's financial decisions (Fernandes et al., 2014;Henager & Cude, 2016;Gathergood & Weber, 2017), which leads us to explore whether individual cognitive biases influence financial decision making more than objective financial knowledge. Not including these cognitive bias factors limits our understanding of how financial behavior can be improved. ...
... Gathergood and Weber (2014) observe that many hold cash in low yield accounts, enough to pay off high cost revolving credit, but they choose to "co-hold" cash and high cost debt. Gathergood and Weber (2017) report that survey respondents with poor financial literacy were self-aware of their financial inexperience and more likely to choose high cost debt such as Alternative Mortgage Products (AMP) with complex back-loaded payments. ...
Article
We examine whether inflated perceptions of financial literacy affect financial decision making. Gaps between objective financial literacy and self-reported (perceived) financial literacy (blind spots) predict 19 financial behaviors better than age, gender, income, ethnicity, marital status, self-employment status, and general education levels. Only two predictors, perceived financial literacy and financial education, carried similar levels of predictive power on financial behaviors. Those with inflated perceptions of financial literacy are more likely to miss mortgage payments, receive a collection call, use informal debt, and have poor banking behavior. Those without blind spots make better financial decisions. The differences between those with and without blind spots are more pronounced among individuals with higher education and income.
... For instance, Tennyson (2011) proposes a ten-question test to measure insurance knowledge, while Lusardi and Tufano (2015) adapt the well-known "Big Three" quiz developed to measure overall financial literacy (Lusardi & Mitchell, 2006) to gauge consumers' debt literacy. Other researchers later applied the adaptation proposed by Lusardi and Tufano (2015) Gathergood and Weber (2017) apply a mortgage literacy measure. None of these instruments have been assessed in terms of their psychometric properties. ...
... Given that our scale is designed to measure only one aspect of financial literacy, its brevity is even more warranted. Our scale is partial in its nature, as are the scales which have been proposed to measure insurance, debt, or investment literacy (Gathergood & Weber, 2017;Lusardi & Tufano, 2015;Tennyson, 2011;Volpe et al., 2002). The scale is intended and designed to measure only one aspect of overall financial knowledge: cashless payments knowledge. ...
Article
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The global digital shift, recently accelerated by the COVID-19 pandemic, requires that consumers have knowledge allowing them to navigate increasingly cashless markets safely and effectively. To enable valid and reliable measurement of such knowledge, we used data obtained from a random sample of adult Poles to develop and evaluate the psychometric properties and applicability of an original cashless payments knowledge scale (CPK scale). Our analyses based on Item Response Theory show that some evident subdomains exist within the CPK construct. The separate dimensions of the CPK merge into a coherent scale with solid psychometric properties. We find that the CPK score depends on the place of residence, education, and household size, and is positively related to safe cashless behavior. Our findings may have important implications for financial institutions as well as policymakers interested in segmenting consumers in terms of their financial knowledge, potential risks resulting from deficits in this knowledge, and enhancing financial literacy. This article is protected by copyright. All rights reserved.
... To capture the choice of naive households, we suppose that absent bank's steering, they choose the easy to grasp (but potentially more costly) FRM. This assumption is in line with extensive empirical evidence that households with lower financial literacy are more likely to choose FRMs (see Agarwal et al. (2010); Fornero et al. (2011); Gathergood and Weber (2017); Albertazzi et al. (2018)), and can be microfounded by the "money doctors" model by Gennaioli et al. (2015). Unlike the sophisticated households, naive households are prone to steering by banks. ...
... This makes the long-term budgeting very simple. Agarwal et al. (2010); Gathergood and Weber (2017); Albertazzi et al. (2018) provide ample empirical evidence from a broad set of countries that indeed households with lower degree of financial literacy are more likely to choose FRMs. Fornero et al. (2011) give evidence for Italian households. ...
... In agreement with these findings, Gathergood & Weber (2015) found that individuals with low financial literacy levels were more likely to use alternative mortgage products than those who had higher levels of financial literacy. Fernandes et al (2013) in a meta-analysis covering 188 prior studies found that financial literacy interventions only explained a 0.1% variance in financial behaviours. ...
Article
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The financial market is a cornerstone in guaranteeing sustainable livelihood of the population, but the effect of financial literacy is a major impediment to inclusive finance. To this effect, this paper seeks to model the impact of financial literacy on the wellbeing of users’ of formal and informal financial services in Kampala. A cross-sectional conclusive case study designed was employed usinga sample of n=370 selected from people employed in the informal sector in Kampala, Uganda. Data was sourced viaquestionnaire survey and analysed using Structural Equation Model. Parametric assumptions were tested and redundant data weredownsized using Exploratory (EFA) and Confirmatory Factor Analysis (CFA). The MCAR Little’s test and the Expectation MaximisationAlgorithm (EMA) were conducted for missing data analysis and the tests of hypotheses were based on the analysis of Structural Equation Model (SEM) using SPSS and SMART-PLS statistical packages. The study revealed that financial literacy is positively associated with usage of informal financial services and financial wellbeing; but negatively associated with usage of formal financial services. To this effect, this study recommends that policy makers and financial educators need to appreciate the role of informal financial services in enhancing financial wellbeing of individuals living in developing countries. This paper thereforeprovides contextual evidence from a developing country perspective to suggest that financial literacy hasgreater effect on the financial wellbeing of individuals more through the use of informal financial services than formal financial services
... The main forms of Internet finance include Internet payment, Internet lending, Internet crowdfunding, Internet fund, Internet insurance, and Internet trust (Hou (2016), Gathergood (2017), Jagtiani (2017), Hong (2017), Xu (2020)). ...
Preprint
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The Internet plays a key role in society and is vital to economic development. Due to the pressure of competition, most technology companies, including Internet finance companies, continue to explore new markets and new business. Funding subsidies and resource inputs have led to significant business income tendencies in financial statements. This tendency of business income is often manifested as part of the business loss or long-term unprofitability. We propose a risk change indicator (RFR) and compare the risk indicator of fourteen representative companies. This model combines extreme risk value with slope, and the combination method is simple and effective. The results of experiment show the potential of this model. The risk volatility of technology enterprises including Internet finance enterprises is highly cyclical, and the risk volatility of emerging Internet fintech companies is much higher than that of other technology companies.
... In assessing credit cardholders' tendency to overspend, they were asked to state how frequently they purchased goods and services even though they were aware that they would not have enough money to make full payment when the bill was due. The question on impulsiveness was adopted from Gathergood (2012) and Gathergood and Weber (2017). To measure impulsiveness, the respondent was asked to state their level of agreement with the statement "You are impulsive and have a tendency to make purchases that you cannot afford". ...
Article
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This paper studies the relationship between socio‐economic factors, financial literacy, money management skill, overspending, and impulsiveness on credit card repayment decisions. Analysis based on a sample of 451 credit card users in Malaysia showed that socio‐economic factors related to education, income, ethnicity, marital status, and number of credit cards held influence credit card repayment decisions. Financial literacy and money management skill have a positive effect on credit cardholders’ decision‐making. Specifically, money management skill related to financial statements monitoring, prompt bill payment, spending within budget and handling money matters well influence credit card repayments. However, personality traits such as overspending and impulsiveness do not exert a significant effect on credit card payment behaviour. The findings of this study support the argument that financial education and behavioural intervention that inculcate good money management skill are important in shaping individuals' behaviour.
... For example, people with a present bias are more likely to borrow from credit cards and borrow more from credit cards compared to those who are not present biased (Meier & Sprenger, 2010). Similarly, present biased consumers are more likely to use complex mortgage products with back-loaded payments, known as "Alternative Mortgage Products" (AMPs), or "Interest-Only Mortgages" (Gathergood & Weber, 2015). Consumers who exhibit lack of selfcontrol make greater use of high-cost credit items such as store cards and payday loans (Gathergood, 2012). ...
Article
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Present bias is an important term in the theory of self‐control in behavioral finance. Empirical research finds that present bias is associated with undesirable spending, borrowing, and saving behaviors. Unlike previous research that focuses on one domain of financial behavior, the purpose of this study is to examine associations between present bias and a set of financial behaviors in various domains: spending, borrowing, saving, and money management. With data from a national urban sample in China, results show that some behavioral patterns are consistent with theoretical predictions that present biased consumers are more likely to spend in the present and less likely to save for the future. The findings have implications for further research on present bias and help researchers better understand this important concept. The results are also informative for financial planners to better serve their clients.
... Looking at the general picture, a lower financial literacy results in a lower level of prosperity and lower financial security for the future (e.g. having no pension or insurance products; Gathergood, 2012b;Gathergood & Weber, 2017). A lower creditworthiness (objective factor) may also have implications for taking out loans without constrains related to the borrower but with terms and conditions that are less favourable for him/her (higher interest rate). ...
Chapter
This chapter is about taking out loans and consumer credit, over-indebtedness, and problems with repaying debt. Firstly, the role of financial knowledge and financial literacy is discussed as the determinants of consumer debt, as well as the role of psychological factors. Taking out loans and consumer credit may be both an element of a good money management strategy as well as a manifestation of irresponsible financial behaviour driven, for instance, by materialism, or impulsive buying behaviour. Even though problems with the repayment of debt may result from financial difficulties (low income), it can also derive from moral and ethical background, e.g. believing that not all debts have to be repaid. Also in the case of debt, the way a person perceives their material situation and money management style has a greater impact on their debting behaviour than the actual level of their earnings and demographic characteristic. Finally, a five-segment model of consumer typology is presented (Forgetful, Indebted for Others, Carefree, Lost in Finances, and Avoiders) where segments differ in their approach to life, their individual psychological characteristics, and their values and moral beliefs that determine their approach to debt and to meeting their financial commitments.
... Looking at the general picture, a lower financial literacy results in a lower level of prosperity and lower financial security for the future (e.g. having no pension or insurance products; Gathergood, 2012b;Gathergood & Weber, 2017). A lower creditworthiness (objective factor) may also have implications for taking out loans without constrains related to the borrower but with terms and conditions that are less favourable for him/her (higher interest rate). ...
Chapter
Financial behaviours like saving, spending, insuring, or borrowing are very often explained by the level of a person’s income. This economic perspective assumes that human behaviours are rational. This chapter discusses the proofs coming from behavioural economics that consumer financial behaviour is not as rational as was assumed earlier, and evidence drawn from the field of social cognition showing that many human behaviours (including financial behaviour) are automatic in nature and that the motives underpinning them are often unconscious. This chapter discusses also the various individual psychological factors affecting economic behaviours, which are both non-specific (not related to finance), like conscientiousness, neuroticism, and self-control, and specific (related to finances), like attitudes towards money, money spending style, and materialism. Taking all this into account when explaining financial behaviours makes it possible to better foresee the seemingly irrational economic decisions (e.g. why a low-income person buys expensive things). A seven-segment typology of consumers created based on a quantitative survey showing the relationships between the individual characteristics of a person and its various financial behaviours is also presented.
... They are not able to estimate loan duration, interest compounding and amortisation. This restricts many people from becoming homeowners (Gathergood & Weber, 2017). The earlier literature on financial literacy induces us to examine the difference vis-à-vis gender perspective. ...
Article
This study covers the gender-wise analysis of how behavioural factors and socio-economic factors along with the level of financial literacy influence investment decisions of Indian retail investors. Equally pertinent is to understand that will it have a different influence and bearing on males and females. Multivariate technique partial least squares-structural equation modelling (PLS-SEM) has been applied to develop the model and analyse the results. The study used a structured questionnaire for collecting data from retail investors. The findings of PLS-SEM show that in both genders, behavioural factors, socio-economic factors and financial literacy factors significantly affect investment decisions. However, the findings demonstrate that for women investors, the model is more effective. This study may be useful for prospective fund managers as, in many earlier studies, women are considered to be risk aversive. The results demonstrate that there is a need to target women, and the scenario today is not similar to the pre-existing ones. JEL Classification: G110, G4
... Fornero et al. (2011) established that those more financially literate more often shop around when they need a mortgage, while those less literate more often accept the first offer they receive. Higher levels of financial literacy are also positively associated with more accurate selfassessment of one's own mortgage contracts (Courchane et al., 2008) and a greater ability to better match loan products to one's own situation (Fornero et al., 2011;Smith et al., 2012;Gathergood and Weber, 2017). Finally, more financially literate debtors are less likely to default on their debts (Gerardi et al., 2010;Fornero et al., 2011;Agarwal et al., 2017). ...
Article
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Borrowing behavior may be more resistant to formal educational treatments than other financial behaviors. In order to study the process and results of infographics-based debt education, we used eye tracking technology (SMI RED 500 Hz) to monitor the oculomotor behavior of 108 participants (68 females) aged 18 to 60 who were shown 4 infographics. The study used an experimental design with repeated measures and an internal comparison group. We also used scales of debt literacy and a set of information literacy scales: numerical, graph, and linguistic. The results confirm that short-term infographics-based debt education can improve debt literacy significantly. The difference in processing the educational contents that were not known to participants before the educational session suggests that participants with better information literacy make more considerable debt literacy progress. Specifically, we found that numerical literacy is a significant mediator of debt education results, depending on the initial level of debt literacy; this relation is moderated by the focus of visual attention on negatives of debt. We found no significant relationship between debt literacy education results and those of graph and linguistic literacy.
... Gathergood (2012) finds that the effect of financial literacy on borrowing is reduced when a variable measuring self-control is included in a regression. Financial literacy and present bias both predict problematic mortgage product decisions by consumers (Gathergood and Weber, 2017). In addition, Razen et al. (2021) show for adolescents that financial literacy positively correlates with experimentally elicited patience and their own perception of their ability to resist temptations. ...
Thesis
Diese Arbeit untersucht den Einfluss verhaltensökonomischer Aspekte und Bildung für die finanzielle Entwicklung. Sie besteht aus vier Kapiteln, welche jeweils ein separates Forschungspapier darstellen. Die Kapitel decken folgende Themen ab: Determinanten einer impulsiven Kreditaufnahme, Hindernisse bei finanzieller Inklusion, die Auswirkungen von finanzieller Bildung und die finanziellen Folgen eines Schocks. Alle Kapitel nutzen Umfragedaten. Außerdem nutzen einige Kapitel experimentelle (Labor-)Ergebnisse. Nach einer Einleitung untersucht Kapitel zwei die Rolle von Selbstkontrolle und finanzieller Bildung bei einer impulsiven Kreditaufnahme und analysiert experimentelle Daten, die in einem Labor in Berlin erhoben wurden, sowie Umfragedaten aus der Innovations-Stichprobe des Sozio-oekonomischen Panels. Kapitel drei trägt zu einem besseren Verständnis der Determinanten und Hindernisse für die Nutzung von Mobile Money in einem einkommensschwachen Land bei, wobei es auch den Beitrag von Mobile Money zur finanziellen Inklusion betrachtet. Da Bildung die Wahrscheinlichkeit erhöht, dass neue Technologien genutzt werden, könnte finanzielle Bildung weitere Bemühungen zur finanziellen Inklusion und zum Verbraucherschutz für die finanzielle Entwicklung sinnvoll ergänzen. Daher ist es wichtig, die Auswirkungen von Programmen zu bewerten, die auf finanzielle Bildung abzielen. Dafür werden in Kapitel vier die Auswirkungen eines Finanzbildungsprogramms und seine Spillover-Effekte anhand einer randomisierten kontrollierten Studie analysiert. Kapitel fünf beleuchtet die Auswirkungen der COVID-19-Pandemie auf das finanzielle Wohlergehen und die Technologienutzung von Kleinstunternehmern. Die in Kapitel drei bis fünf verwenden Daten wurden in zwei groß angelegten Erhebungswellen im ländlichen Uganda erhoben.
... The effect of mortgage delinquency in this research cannot be explained by the respondents' characteristics (e.g., income or property characteristics). Additionally, Gerardi et al. (2013) confirmed that numerical ability predicts mortgage default, and people with a lower financial literacy take on more expensive loans (Moore 2003;Gathergood and Weber 2017). ...
Article
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The COVID-19 pandemic has shown how important it is to prepare one’s own financial budget for the unexpected loss of income. In this dimension, the financial education of the society plays an invaluable role. It allows us to account for events that may adversely affect personal finances in our budget management decisions. Therefore, the aim of the article is to check whether households with a higher level of financial and debt literacy have better management skills from the perspective of a household’s budget, which in the face of a crisis reduces the risk of individuals not paying their liabilities. Thus, at the turn of June and July 2020, we conducted surveys among 1300 Polish citizens. Using the multinomial logistic regression, we show that people with a higher financial and debt literacy are less affected by overindebtedness. During the crisis, people who have a higher debt literacy are better prepared to manage credit liabilities; in this situation, financial literacy is less important. In addition, the type of credit experience turned out to be significant. Respondents who have experience with consumer loans (potentially high-margin products) are more likely to have debt repayment problems than those with mortgage loans experiences.
... Others presented risky securities to consumers as if they were safe investments. Such activities reduce lending standards and increase loan delinquency rates while boosting the supply of loans and financier profits (Dell'Ariccia et al., 2012;Gathergood and Weber, 2017;Henderson and Pearson, 2009;Loutskina and Strahan, 2009;Mian and Sufi, 2009;Nejad and Estelami, 2012). As automated financial services become more prevalent, these risks may increase as consumers receive more automated self-service advice and recommendations. ...
Article
Purpose The financial industry offers a unique setting to study innovations. Financial innovations have fueled the growth of economies, markets and societies. The financial industry has successfully become the breeding ground for innovative services, processes, business models and technologies. This study seeks to provide a holistic view of the literature on financial innovations, synthesize the research findings and offer future directions for research in light of three market developments that are disrupting the industry and opening up a new era for the financial services industry. Disruptions from within and outside the industry offer new generations of radically innovative services. Moreover, new generations of consumers differ from previous generations in their needs and wants and look for innovative ways to handle their financial needs. Finally, significant developments related to financial innovations have emerged in Asia and developing countries. Design/methodology/approach This study systematically reviews the academic research literature on financial innovations in two phases. The first phase provides a quantitative review of 546 journal articles published between 1990 and 2018. In the second phase, the study synthesizes the extant research on financial innovations and maps them in five research areas: firms' introduction and adoption of FIs, financial innovation development, the outcomes of financial innovations, regulations and intellectual property, and consumers. Findings The analysis found that disciplines differ with regard to the employed research methodologies, the units of analysis, sources of data and the innovations they examined. A positive trend in the number of published articles during this period is observed. However, studies have primarily focused on the USA and Europe and less so on other parts of the world. The literature synthesis further identifies research gaps in the available research that highlight future research opportunities in light of the three market disruptions. The financial services industry is on the brink of a new era due to disruptions from within and outside the industry and the entrance of new generations of consumers. Moreover, the financial industry has successfully become the breeding ground for innovative services, processes and business models. Therefore, financial innovations offer promising opportunities for bridging the gap between research on product and service innovations. Research limitations/implications The work provides a holistic and systematic overview of extant research on financial innovations and highlights future research opportunities in light of the three disruptive market developments. It helps researchers take advantage of the opportunities in studying financial innovations while maintaining industry relevance. Originality/value The study is the first to review and synthesize the academic research literature on financial innovations across marketing, finance and innovation disciplines. In addition, the study highlights three primary disruptive forces in the financial industry and identifies future research directions in light of these disruptive forces.
... Others presented risky securities to consumers as if they were safe investments. Such activities reduce lending standards and increase loan delinquency rates while boosting the supply of loans and financier profits (Dell'Ariccia et al., 2012;Gathergood and Weber, 2017;Henderson and Pearson, 2009;Loutskina and Strahan, 2009;Mian and Sufi, 2009;Nejad and Estelami, 2012). As automated financial services become more prevalent, these risks may increase as consumers receive more automated self-service advice and recommendations. ...
Research
Full-text available
The financial industry offers a unique setting to study innovations. Financial innovations (FIs) have fueled the growth of economies, markets, and societies. The financial industry has successfully become the breeding ground for innovative services, processes, business models, and technologies. Three market developments are disrupting the industry and opening up a new era for the financial services industry. Disruptions from within and outside the industry offer new generations of radically-innovative services. Moreover, new generations of consumers differ from previous generations in their needs and wants and look for innovative ways to handle their financial needs. Finally, significant developments related to financial innovations have emerged in Asia and developing countries. In light of these market disruptions, this study systematically reviews the academic research literature on FIs in two phases. The first phase provides a quantitative review of 546 journal articles published between 1990 and 2018. This analysis found that disciplines differ with regard to the employed research methodologies, the units of analysis, sources of data, and the innovations they examined. The analysis found a positive trend in the number of published articles during this period. However, studies have primarily focused on the US and Europe and less so on other parts of the world. In the second phase, the study synthesizes the extant research on FIs and maps them in five research areas: firms' introduction and adoption of FIs, financial innovation development, the outcomes of financial innovations, regulations and intellectual property, and consumers. This synthesis further identifies research gaps in the available research that highlight future research opportunities in light of the three market disruptions.
... 3 Search costs, time constraints, brand loyalty, negotiation ability, they all offer a reasonable explanation for this (as in Allen et al. 2014a andin Allen et al. 2019), and they do even more so in a market, like the Italian one, dominated by traditional brick-and-mortar banks, where contracts are mainly settled at the physical branch. 4 It should also be noted that mortgages are complex products and some of their features might result obscure to households, or might require some degree of financial literacy which they lack (Hall & Woodward 2012;Gathergood & Weber 2017). This creates a demand for information and makes borrowers genuinely inclined to trust the intermediary with superior brand name. ...
Thesis
In the first chapter, I exploit the rebranding of a mortgage lender, under a more salient name and in some Italian provinces, to empirically analyze households’ choice behaviour in response to brand popularity. Loan-level data on both the universe of newly originated mortgages and the offer rates suggest that (1) brand awareness reduces the equilibrium price of residential mortgage contracts and (2) the reduction mainly reflects consumers’ selection into cheaper products. Comparing contracted rates with concurrent market offers from the main online mortgage broker in Italy, I show that households’ reallocation towards less expensive choices is unlikely to reflect pure substitution behaviours induced by brand persuasion. In fact, my findings support the informative view that brand awareness improves consumers’ search and allows them to obtain more convenient deals, with an overall decrease in price dispersion. In the second chapter, we back empirical findings with theoretical foundations, and quantify the impact of brand name on consumers’ search costs and borrowers’ transition across lenders within a life-cycle model. The model is well calibrated to replicate main features of the Italian household sector and to match the level of dispersion in the price of mortgage products encountered in the data. Model calibrations imply a 330 euro reduction in consumers’ search costs due to brand popularity, and roughly a 10 percentage points increase in the share of households that move to cheaper lenders. The treatment effect of brand name on price dispersion is in line with the empirical evidence in chapter one. In the third chapter, we use information on mortgage supply available from the online broker to assess trends in lending strategies of Italian banks. We document that (1) riskier mortgages (high loan-to-value, low borrower’s income, and long maturity) are offered by fewer banks that charge higher rates; (2) keeping the level of risk constant, online banks offer better price conditions than traditional ones. We then use online offer rates to nowcast bank-level official rates (MIR). By relying on both regression analysis and machine learning algorithms (random forest), we show that online prices have a high predictive content for the equilibrium price of fixed-rate mortgages, and allow for a very timely assessment of changes in household financing conditions.
... Yet in the presence of forecast errors, over-optimism or over-confidence, the option to defer payments may result in welfare losses through consumers triggering contingent interest rates, fees and charges (Grubb, 2009). As with the case of alternative mortgage products, BNPL allows consumption smoothing, but presents the possibility for financially unsophisticated or present focused consumers to over-consume in the near term, due to limited commitment (O'Donoghue and Rabin, 1999;Mian and Sufi, 2009;Campbell et al., 2011a;Cocco, 2013;Gathergood and Weber, 2017). 7 BNPL may be profitable because it drives increased, potentially impulsive, merchant sales producing high merchant fees in commission to BNPL lenders to such an extent that lenders' have limited incentives to consider the consumers' creditworthiness or the broader effects of borrowing on their welfare. ...
Preprint
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We show consumers taking out buy now, pay later (BNPL) - an interest-free FinTech product enabling consumers to defer payments into instalments - commonly charge instalments to their credit card (a higher interest rate product). We find $19.5\%$ of credit cardholders in our UK transactions data charged at least one BNPL instalment to their credit card in 2021: a practice $24\%$ more prevalent in the most deprived geographies and among younger consumers. Our analysis provides an example of how consumer financial protection regulators can use real-time transactions data to monitor markets and evaluate potential risks - especially (largely) unregulated, financial innovations such as BNPL.
... The milestone transition from various schemes of share participation to project financing in housing construction has been widely discussed in the scientific community, especially in the last 3 years. Nevertheless, the perspectives of the project financing have been estimated earlier for some large projects in the Russian Federation, while abroad this method of financing has a wellestablished long-standing practice [3,9,11]. ...
Article
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The problem of providing comfortable and affordable housing for Russian citizens as a national goal has gained an impetus to solution after the introduction at the legislative level of project financing for housing construction using escrow accounts. The application of this new method of financing to the decision-making algorithm of a developer requires mathematical modeling of the economic ratios of the main indicators of the developer’s activities, taking into account the interests of other subjects in the housing construction sector: banks and population. The approach proposed by the authors is aimed primarily at expanding the supply in the housing market. We have formalized the possible sale strategies of the developer using a matrix approach in varying prices and the number of meters sold at different stages of construction, as well as interest rates for bank crediting, depending on the degree of escrow accounts accumulation. Testing the model has shown that developers should face serious problems related to increasing the cost of replenishing working capital for the construction process, which will inevitably be included in the price per square meter of housing and paid by the consumer (population). At the same time, banks become the main controllers and beneficiaries of the project financing. The model developed and tested by the authors will allow construction organizations to overcome the first difficulties of project financing application and competently and consistently make a choice of a strategy for offering housing to buyers, taking into account the variability of the economic parameters of all parties.
... They are not able to estimate loan duration, interest compounding and amortization. So this is a barrier for less sophisticated households in becoming homeowners (Gathergood 2017). The more one reads literature on the impact of financial literacy on investment decisions, the more one is inclined to examine this factor in further detail. ...
Conference Paper
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This study covers the gender-wise analysis of behavioural factors, socio-economic factors & financial literacy on investment decisions of Indian retail investors’. Equally pertinent is to understand that will it have a different impact on males and females. The study uses a structured questionnaire for collecting data from stock brokerage executives and managers. Multivariate technique PLS-SEM has been applied to develop the model and analyze the results. The findings of PLS-SEM show that in both genders behavioural factors, socio-economic & financial literacy factors have a significant direct impact on investment decisions. However, the findings clearly demonstrate that for men investors the model is more effective. This study may be useful for prospective fund managers as in many earlier studies women are considered to be risk aversive. The results clearly demonstrate that there is a need to target women and the scenario today is not similar to pre-existing one.
... The promotion and provision of financial literacy education should be considered an important tool for increasing well-being at the onset of a credit decision. Financial literacy has been already proven to facilitate a better selection of credit products (Fornero et al. 2011) and decrease the cost of debt (Bialowolski et al. 2020;Gathergood and Weber 2017). Thus, it can translate into higher satisfaction with credit and consequently with life in general. ...
Article
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This study evaluated the short-term links between different forms of household debt – credit card debt, student debt, debt from relatives, mortgage debt, car debt, and debt arrears – and life satisfaction. To this end, a longitudinal dataset for the US population from the Panel Study of Income Dynamics (PSID) was used and the propensity score difference-in-differences approach was applied. Credit card debt and student loans negatively impacted life satisfaction in the short term (up to two years). Mortgages and external financing for a car, however, were found to increase life satisfaction. The effects associated with the beginning and repayment of a loan turned out to not be symmetrical – the end of any type of loan contract was not related to life satisfaction. In the case of involuntary debt (i.e., mortgage arrears), a significant negative impact on life satisfaction was noted when problems emerged, while a positive effect was found when the debts were paid off.
... Berlinger [12] argued that the calculation method of APRC misleads the borrowers and strengthens their myopic view. Several authors found that personal traits and psychological effects also play a role in borrowers' choice [13][14][15], while Albertazzi et al. [16] and Gathergood and Weber [17] emphasized the effects of education and financial literacy. The product characteristics are more complicated in the case of ARMs as compared to FRMs since installments are not a linear function of interest rates [18]. ...
Article
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We investigate the problem of interest rate risk transforming into default risk of adjustable-rate mortgage loans in the EU. Bank regulation is strikingly not neutral in this aspect, it explicitly favors short-duration adjustable-rate loans over long-duration fixed-rate loans in the framework of the gap management. This asymmetry in the regulation creates perverse incentives both for banks and households, which can lead to aggressive risk-taking, over-indebtedness of unhedged households, high procyclicality of mortgage markets, and increased systemic risks. We present a stress test model to quantify potential losses stemming from this specific risk from the perspective of lender institutions. We estimate the average extra capital that is needed to cover the additional risk of adjustable-rate mortgage loans in the EU to be 0.53% of the value of the total mortgage portfolio and 1.97% of the value of the adjustable-rate mortgage portfolio. We propose introducing a stress test model as a new mandatory element into banks’ risk management framework.
Article
This study examines the relationships between financial knowledge, confidence, learning capacity, education and other sociodemographic information and financial behavior. A structural equation model is used to analyze the relationships between the study variables and to obtain a more comprehensive understanding of the factors linked to poor financial behavior among a large Canadian sample. The main findings showed that financial confidence plays a crucial role in explaining financial behavior and that learning capacity explains financial confidence. Overall, our results suggest that financial education should be considerably improved and that additional focus should be placed on financial confidence and individual’s learning capacity in order to mitigate existing financial difficulties, prevent new problems from arising, and develop and implement constructive strategies to achieve specific financial goals. This study contributes to previous research on financial literacy by demonstrating the influence of learning capacity on financial confidence and financial behavior.
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Encouraging consumers to switch to lower-rate mortgages is important both for the individual consumer’s finances and for functioning competitive markets, but switching rates are low. Given the complexity of mortgages, one potential regulatory intervention that may increase switching rates is to provide independent advice on how to select good mortgage products and how to navigate the switching process. Working with a government consumer protection agency, we conducted an experiment with mortgage-holders to test whether such advice alters perceptions of switching. The experiment tested how (i) the attributes of the offer, (ii) perceptions about the switching process, (iii) individual feelings of competence and (iv) comprehension of the product affect willingness to switch to better offers, both before and after reading the official advice. The advice made consumers more sensitive to interest rate decreases, especially at longer terms. It also increased consumers’ confidence in their ability to select good offers. Overall, the findings imply that advice from policymakers can change perceptions and increase switching rates. Moreover, the experiment demonstrates how lab studies can contribute to behaviourally-informed policy development.
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Cambridge Core - Financial Law - Personal Debt in Europe - by Federico Ferretti
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We study a quasi-natural experiment that altered the structure of commission fee schedules applied to retail investors in the Portuguese stock market in 2003. Using a difference-in-differences analysis, we show that investors with a university degree, financial knowledge and numerical skills demonstrate greater ability and eagerness in adjusting their trading patterns to the new commission schedules. The impact of education was stronger for those lacking trading experience. Investors with a university degree that were more prone to issue small orders before the event were also more eager to scale up their order size.
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In the past decade, evidence has been accumulated on the relationship between im- pulsivity and over-indebtedness. Nevertheless, the magnitude of such association is still considered marginal compared to traditional socio-demographic and economic factors, with the important consequence that impulsivity continues to be ignored in policy interventions for preventing and dealing with over-indebtedness. The aim of this study was to meta-analyse existing studies with the aim to answer the ques- tion: Are higher levels of impulsivity associated with greater over-indebtedness? Scopus and Web of Science databases were searched for English language studies. Seventeen studies were eligible for the analysis. The random effect model yielded a significant positive association between impulsivity and over-indebtedness (Hedges' g = .40). Type of over-indebtedness (debt holding vs. unmanageable debt) and work status (percentage of employed individuals) significantly moderated this association. Results are discussed in terms of implications and recommendations for future re- search, policy and practice.
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Investors differ in their decisions with respect to risk, returns and market analysis. The present study attempts to examine the influence of financial literacy on retail investors' decisions in relation to return, risk and market analysis. The study uses convenience sampling to collect data from the retail investors through stock brokerage managers. Factor analysis has been employed for understanding factors of financial literacy. Financial literacy is composed of Accounting Information; Market Information; Broad Overview; and Technical Knowledge. The factors of Investment decisions are: Return Analytics; Risk Analytics; and Market. The risk and return analytics have stronger impact on investors decision than market analytics. PLS SEM has been employed for examining relation between financial literacy and Investment decision. The results suggest a significant positive relation between financial literacy and investment decision.
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This research seeks to identify gaps in financial knowledge and behaviors between immigrants to Canada and individuals who are born in Canada. The research aims to evaluate to what extent immigrants involve themselves in financial planning and avoid harmful financial behaviors. Employing the Canadian Financial Capability Survey (2009), the findings of the study suggest that immigrants are less likely to show high levels of financial knowledge compared to born citizens. The knowledge gap between immigrants and born citizens narrows as an individual resides longer in Canada. In addition, immigrants are less likely to prepare themselves financially for their retirement or to have long‐term investments. The findings provide a basis for addressing the implications of weak financial knowledge. This article is protected by copyright. All rights reserved.
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Experiment Findings
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In recent years, machine learning techniques have assumed an increasingly central role in many areas of research, from computer science to medicine, including finance. In the current study, we applied it to financial literacy to test its accuracy, compared to a standard parametric model, in the estimation of the main determinants of financial knowledge. Using recent data on financial literacy and inclusion among Italian adults, we empirically tested how tree-based machine learning methods, such as decision trees, random, forest and gradient boosting techniques, can be a valuable complement to standard models (generalized linear models) for the identification of the groups in the population in most need of improving their financial knowledge.
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We investigate whether car buyers are myopic about future fuel costs. We estimate the effect of gasoline prices on short-run equi-librium prices of cars of different fuel economies. We then compare the implied changes in willingness-to-pay to the associated changes in expected future gasoline costs for cars of different fuel economies in order to calculate implicit discount rates. Using different as-sumptions about annual mileage, survival rates, and demand elas-ticities, we calculate a range of implicit discount rates similar to the range of interest rates paid by car buyers who borrow. We interpret this as showing little evidence of consumer myopia. According to EPA estimates, gasoline combustion by passenger cars and light-duty trucks is the source of about fifteen percent of U.S. greenhouse gas emissions, "the largest share of any end-use economic sector." 1 As public concerns about cli-mate change grow, so does interest in designing policy instruments that will reduce carbon emissions from this source. In order to be effective, any such policy must reduce gasoline consumption, since carbon emissions are essentially proportional to the amount of gasoline used. The major policy instrument that has been used so far to influence gasoline consumption in the U.S. has been the Corporate Av-erage Fuel Efficiency (CAFE) standards (Pinelopi K. Goldberg (1998), Mark R. Jacobsen (2010)). Some economists, however, contend that changing the incen-tives to use gasoline—by increasing its price—would be a preferable approach. This is because changing the price of gasoline has the potential to influence both what cars people buy and how much people drive., and Yale. We also thank participants at the ASSA, Milton Friedman Institute Price Dynamics Conference, NBER IO, EEE, and Price Dynamics conferences, and the National Tax Association. We thank the University of California Energy Institute (UCEI) for financial help in acquiring data. Busse and Zettelmeyer gratefully acknowledge the support of NSF grants SES-0550508 and SES-0550911. Knittel thanks the Institute of Transportation Studies at UC Davis for support. 1 EPA, Inventory of U.S. Greenhouse Gas Emissions and Sinks: 1990-2006, p. 3-8.
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In this paper, we undertake an assessment of the rapidly growing body of research on financial literacy. We start with an overview of theoretical research which costs financial knowledge as a form of investment in human capital. Endogenizing financial knowledge has important implications for welfare as well as policies intended to enhance levels of financial knowledge in the larger population. Next, we draw on recent surveys to establish how much (or how little) people know and identify the least financially savvy population subgroups. This is followed by an examination of the impact of financial literacy on economic decision-making in the United States and elsewhere. While the literature is still growing, conclusions may be drawn about the effects and consequences of financial illiteracy and what works to remedy these gaps. A final section offers thoughts on what remains to be learned if researchers are to better inform theoretical and empirical models as well as public policy.
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This paper analyzes how financial literacy and reported willingness to take financial risk impact a household’s choice of mortgage type. The results show that households reporting higher financial literacy and lower risk aversion are 55 to 97 percent more likely to opt for interest-only mortgages. The results are robust to alternative explanations such as the involvement of financial advisors, the effect of peers, experience with prior home-ownership, and house price expectations. In general, alternative mortgage products, as opposed to traditional mortgages, are chosen by wealthier, older, and more sophisticated households that are more likely to have a greater understanding of the risks and benefits associated with these products.
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I examine tenure and mortgage choice in an equilibrium model in which households make decisions as if they discount hyperbolically rather than exponentially. Overall, hyperbolic discounting does not seem to explain the high rates of home ownership or portfolio concentration in housing in the data. I then study the choice between mortgages that require a substantial down payment and mortgages that require no down payment. Allowing households access to no down payment mortgages exacerbates rather than mitigates the undersaving of hyperbolic discounters. However, even when households discount hyperbolically, welfare is higher when households have access to no down payment mortgages.
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We present an intertemporal consumption model of consumer investment in financial literacy. Consumers benefit from such investment because their stock of financial literacy allows them to increase the returns on their wealth. Since literacy depreciates over time and has a cost in terms of current consumption, the model determines an optimal investment in literacy. The model shows that financial literacy and wealth are determined jointly, and are positively correlated over the life cycle. Empirically, the model leads to an instrumental variables approach, in which the initial stock of financial literacy (as measured by math performance in school) is used as an instrument for the current stock of literacy. Using microeconomic and aggregate data, we find a strong effect of financial literacy on wealth accumulation and national saving, and also show that ordinary least squares estimates understate the impact of financial literacy on saving.
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Alternative mortgage products were identified by many as culprits in the financial crisis. However, because of their lower initial mortgage payments relative to loan amount, they may be a valuable tool for households who expect higher and more certain future labor income, and who wish to smooth consumption over the life-cycle. This paper uses United Kingdom household level panel data to show evidence in support of this hypothesis and on other important benefits of alternative mortgages, including portfolio diversification, tax benefits, and a reduction in the transaction costs incurred in housing transactions.
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Economists and psychologists have devised numerous instruments to measure time preferences and have generated a rich literature examining the extent to which time preferences predict important outcomes; however, we still do not know which measures work best. With the help of a large sample of non-student participants (truck driver trainees) and administrative data on outcomes, we gather four different time preference measures and test the extent to which they predict both on their own and when they are all forced to compete head-to-head. Our results suggest that the now familiar (β, δ) formulation of present bias and exponential discounting predicts best, especially when both parameters are used.
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Mortgage contract design has been identified as a contributory factor in the recent market crisis. Here we examine alternative mortgage products (including interest-only and other deferred amortization structures) and develop a game theoretic model of contract choice given uncertain future income and house prices across different types of borrowers. Results imply that deferred amortization contracts are more likely to be selected in housing markets with greater expected price appreciation and by households with greater risk tolerance; moreover, such products necessarily entail greater default risk, especially among lower-income households who are aggressive in housing consumption levels. Empirical tests of model predictions generally provide support for the theory.
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This article studies optimal mortgage design in a continuous-time setting with volatile and privately observable income, costly foreclosure, and a stochastic market interest rate. We show that the features of the optimal mortgage are consistent with an option adjustable-rate mortgage (option ARM). Under the optimal contract, the borrower is given discretion of how much to repay until his balance reaches a certain limit. The default rates and interest rate payment on the mortgage correlate positively with the market interest rate. Gains from using the optimal contract relative to simpler mortgages are the biggest for those who face more income variability, buy pricey houses given their income level, or make little or no down payment. Our model thus may help to explain a high concentration of option ARMs among riskier borrowers. The Author 2010. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org., Oxford University Press.
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Individuals are increasingly put in charge of their financial security after retirement. Moreover, the supply of complex financial products has increased considerably over the years. However, we still have little or no information about whether individuals have the financial knowledge and skills to navigate this new financial environment. To better understand financial literacy and its relation to financial decision-making, we have devised two special modules for the DNB Household Survey. We have designed questions to measure numeracy and basic knowledge related to the working of inflation and interest rates, as well as questions to measure more advanced financial knowledge related to financial market instruments (stocks, bonds, and mutual funds). We evaluate the importance of financial literacy by studying its relation to the stock market: Are more financially knowledgeable individuals more likely to hold stocks? To assess the direction of causality, we make use of questions measuring financial knowledge before investing in the stock market. We find that, while the understanding of basic economic concepts related to inflation and interest rate compounding is far from perfect, it outperforms the limited knowledge of stocks and bonds, the concept of risk diversification, and the working of financial markets. We also find that the measurement of financial literacy is very sensitive to the wording of survey questions. This provides additional evidence for limited financial knowledge. Finally, we report evidence of an independent effect of financial literacy on stock market participation: Those who have low financial literacy are significantly less likely to invest in stocks.
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This paper studies risk attitudes using a large representative survey and a complementary experiment conducted with a representative subject pool in subjects' homes. Using a question asking people about their willingness to take risks “in general”, we find that gender, age, height, and parental background have an economically significant impact on willingness to take risks. The experiment confirms the behavioral validity of this measure, using paid lottery choices. Turning to other questions about risk attitudes in specific contexts, we find similar results on the determinants of risk attitudes, and also shed light on the deeper question of stability of risk attitudes across contexts. We conduct a horse race of the ability of different measures to explain risky behaviors such as holdings stocks, occupational choice, and smoking. The question about risk taking in general generates the best all-round predictor of risky behavior.
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We compare wealth holdings across two cohorts of the Health and Retirement Study: the early Baby Boomers in 2004, and individuals in the same age group in 1992. Levels and patterns of total net worth have changed relatively little over time, though Boomers rely more on housing equity than their predecessors. Most important, planners in both cohorts arrive close to retirement with much higher wealth levels and display higher financial literacy than non-planners. Instrumental variables estimates show that planning behavior can explain the differences in savings and why some people arrive close to retirement with very little or no wealth.
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We study how the term structure of interest rates relates to mortgage choice at both household and aggregate levels. A simple utility framework of mortgage choice points to the long-term bond risk premium as distinct from the yield spread and the long yield as a theoretical determinant of mortgage choice: when the bond risk premium is high, fixed-rate mortgage payments are high, making adjustable-rate mortgages more attractive. We confirm empirically that the bulk of the time variation in both aggregate and loan-level mortgage choice can be explained by time variation in the bond risk premium, whether bond risk premia are measured using forecasters' data, a vector autoregressive (VAR) term structure model, or a simple household decision rule based on adaptive expectations. The household decision rule moves in lock-step with mortgage choice, lending credibility to a theory of strategic mortgage timing by households.
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Some individuals borrow extensively on their credit cards. This paper tests whether present-biased time preferences correlate with credit card borrowing. In a field study, we elicit individual time preferences with incentivized choice experiments, and match resulting time preference measures to individual credit reports and annual tax returns. The results indicate that present-biased individuals are more likely to have credit card debt, and have significantly higher amounts of credit card debt, controlling for disposable income, other socio-demographics, and credit constraints.
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Many policy makers and economists argue that financial literacy is key to financial well-being. But why do many individuals remain financially illiterate despite the apparent importance of being financially informed? This paper presents results of a field study linking individual decisions to acquire personal financial information to a critical, and normally unobservable, characteristic: time preferences. We offered a short, free credit counseling and information program to more than 870 individuals. About 55 percent chose to participate. Independently, we elicited time preferences using incentivized choice experiments both for individuals who selected into the program and those who did not. Our results show that the two groups differ sharply in their measured discount factors. Individuals who choose to acquire personal financial information through the credit counseling program discount the future less than individuals who choose not to participate. Our results suggest that individual time preference may explain who will and who will not choose to become financially literate. This has implications for the validity of studies evaluating voluntary financial education programs and policy efforts focused on expanding financial education.
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The authors examine self-control problems--modeled as time-inconsistent, present-biased preferences--in a model where a person must do an activity exactly once. They emphasize two distinctions: do activities involve immediate costs or immediate rewards, and are people sophisticated or naive about future self-control problems? Naive people procrastinate immediate-cost activities and preproperate--do too soon--immediate-reward activities. Sophistication mitigates procrastination but exacerbates preproperation. Moreover, with immediate costs, a small present bias can severely harm only naive people, whereas with immediate rewards it can severely harm only sophisticated people. Lessons for savings, addiction, and elsewhere are discussed.
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We study a two-period model where ex ante inferior choice may tempt the decision-maker in the second period. Individuals have preferences over sets of alternatives that represent second period choices. Our axioms yield a representation that identifies the individual's commitment ranking, temptation ranking, and cost of self-control. An agent has a preference for commitment if she strictly prefers a subset of alternatives to the set itself. An agent has self-control if she resists temptation and chooses an option with higher ex ante utility. We introduce comparative measures of preference for commitment and self-control and relate them to our representations. Copyright The Econometric Society.
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This article analyzes the dynamics of the commonly used indices for Adjustable Rate Mortgages, and systematically compares the effects of their time series properties on the interest rate sensitivity of adjustable rate mortgages. Our ARM valuation methodology allows us simultaneously to capture the effects of index dynamics, discrete coupon adjustment, mortgage prepayment, and both lifetime and periodic caps and floors. We can, moreover, either calculate an optimal prepayment strategy for mortgage holders, or use an empirical prepayment function. We find that the different dynamics of the major ARM indices lead to significant variation in the interest rate sensitivities of loans based on different indices. We also find that changing assumptions about contract features, such as loan caps and coupon reset frequency, has a significant, and in some cases unexpected, impact on our results.
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Though economists assume that intertemporal preferences are time-consistent, evidence suggests that a person 's relative preference for well-being at an earlier moment over a later moment increases as the earlier moment gets closer. We explore the behavioral and welfare implications of such time-inconsistent preferences in a simple model where a person must engage in an activity exactly once during some duration. We focus on two sets of distinctions. First, do choices involve salient costs # where the costs of an action are immediate but any rewards are delayed # or do they involve salient rewards # where the rewards of an action are immediate but any costs are delayed? Second, are people sophisticated #theyforesee future self-control problems # or are they naive # they do not anticipate these self-control problems? Naive people procrastinate activities with salient costs and preproperate #dotoo soon # activities with salient rewards. If costs are salient, sophistication mitigates procrastination, and can even lead sophisticated people to do the activity sooner than if they had no self-control problem . If rewards are salient, sophistication exacerbates preproperation. These behavioral results have corresponding welfare implications: With salient costs, mild self-control problems can severely damage a person only if she is naive, while with salient rewards mild self-control problems can severely damage a person only if she is sophisticated. We also consider a multiple-activity version of the model, and discuss how our results might apply to savings, addiction, and other behaviors. Keywords: Doing It, Hyperbolic Discounting, Preproperation, Procrastination, Time Inconsistency. JEL Classifications: A12, B49, C70, D11, D60, D74, D91, E21 Acknowledgments: We thank Steven Bl...
A Debt Puzzle Accepted version
  • D Laibson
  • A Repetto
  • J Tobacman
Laibson, D., Repetto, A., and Tobacman, J. (2003). A Debt Puzzle. In P. Aghion, R. Frydman, Accepted version, Journal of Banking & Finance, in press. http://dx.doi.org/10.1016/j.jbankfin.2017.01.022
Dealing fairly with interest-only mortgage customers who risk being unable to repay their loan. FCA Guidance Reports
Financial Conduct Authority. (2013). Dealing fairly with interest-only mortgage customers who risk being unable to repay their loan. FCA Guidance Reports, FG13/7.