Household Finance Working Group

December 16, 2011
Brigitte C. Madrian of Harvard University's Kennedy School of Government and Nicholas S. Souleles of University of Pennsylvania's Wharton School, Organizers

James J. Choi, Yale University and NBER; Emily Haisley, Barclays Bank PLC; Jennifer Kurkoski, Google, Inc.; and Cade Massey, Yale University
Small Cues Change Savings Choices

In randomized field experiments, Choi, Haisley, Kurkoski, and Massey embedded one- to two-sentence anchoring, goal setting, or savings threshold cues in emails to employees about their 401(k) savings plan. The researchers find that anchors increase or decrease 401(k) contribution rates by up to 1.4 percent of income. A high savings goal example raises contribution rates by up to 2.2 percent of income. Highlighting a higher savings threshold in the match incentive structure raises contributions by up to 1.5 percent of income relative to highlighting the lower threshold. Highlighting the maximum possible contribution rate raises contribution rates by up to 2.9 percent of income among low savers.

Victor Stango, University of California at Davis, and Jonathan Zinman, Dartmouth College and NBER
Borrowing High vs. Borrowing Higher: Sources and Consequences of Dispersion in Individual Borrowing Costs

For many households, paying lower borrowing costs is the surest, fastest way to increase net worth. Using administrative, credit bureau, and survey data on U.S. credit cards, Stango and Zinman find pervasive and systematic cross-individual variation in borrowing costs. Credit risk and product differentiation explain about one-third of that variation. The remaining risk adjusted dispersion can materially affect wealth accumulation: moving heavy borrowers from the 75th to the 25th percentile of risk-adjusted borrowing costs increases their savings rates by more than a percentage point. Debt (mis)-allocation conditional on cards held could matter in principle, but appears to matter very little in practice, because most people allocate debt to their lowest-rate cards. Rather, similarly risky borrowers often hold cards with very different contract APRs. Heterogeneity in consumer search behavior appears to be an important factor in explaining that contract APR variation - a factor nearly as important as credit risk in explaining the cross section of borrowing costs.

Raymond Fisman, Columbia University and NBER; Daniel Paravisini, Columbia University and NBER; and Vikrant Vig, London Business School

Social Proximity and Loan Outcomes: Evidence from and Indian Bank

Fisman, Paravisini, and Vig present evidence that shared codes, religious beliefs, ethnicity -- cultural proximity -- between lenders and borrowers improves the efficiency of credit allocation. They identify in-group preferential treatment using dyadic data on the religion and caste of bank officers and borrowers from a bank in India, and a rotation policy that induces exogenous matching between officers and borrowers. Cultural proximity increases the intensive and extensive margins of lending, increases dispersion in loan size across borrowers, and reduces the collateral-to-loan ratio. In-group officers allocate more credit to borrowers who perform better ex post, although average repayment performance is unaffected, resulting in an increase in weighted average loan performance that persists after an in-group officer's departure. Overall, these findings suggest that cultural proximity improves the precision of information that officers receive about borrower creditworthiness.

Justine S. Hastings, Brown University and NBER, and Ali Hortacsu and Chad Syverson, University of Chicago and NBER
Advertising and Competition in Privatized Social Security: The Case of Mexico

Manuel Adelino, Dartmouth College; Antoinette Schoar, MIT and NBER; and Felipe Severino, MIT
Credit Supply and House Prices: Evidence from Mortgage Market Segmentation

Adelino, Schoar, and Severino show that easier access to mortgage credit significantly increases house prices by using exogenous changes in the conforming loan limit as an instrument for easier credit supply and cheaper cost of credit. They find that houses that become eligible for financing with a conforming loan show an increase in house value of 1.1 dollars per square foot (for an average price per square foot of 224 dollars) and thus higher overall house prices, controlling for a rich set of house characteristics. These coefficients are consistent with a local elasticity of house prices to interest rates that is below 6. In addition, loan-to-value ratios around the conforming loan limit deviate significantly from the common 80 percent norm, which confirms that it is an important factor in the financing choices of home buyers. In line with this interpretation, the results are stronger in the first half of the sample (1998-2001) when the conforming loan limit was more important, given that other forms of financing were less common and substantially more expensive.

Lee Lockwood, University of Chicago
Incidental Bequests: Bequest Motives and the Choice to Self-Insure Late-Life Risks

Retirees face significant uncertainty about how long they will live and, in many countries, how much costly health care they will require. Yet few buy life annuities or long-term care insurance to insure these risks. Low rates of long-term care insurance coverage are often interpreted as evidence against the importance of bequest motives, since failing to buy insurance exposes bequests to significant risk. However, Lockwood finds that low rates of long-term care insurance coverage, especially in combination with the slow rate at which many retirees draw down their wealth, constitute evidence in favor of bequest motives. He uses the Method of Simulated Moments to estimate a life-cycle model of retirement based on the saving and long-term care insurance decisions of U.S. retirees. Retirees' choices are highly inconsistent with standard life-cycle models in which people care only about their own consumption, but they match well models in which bequests are luxury goods. Such bequest motives reduce the value of insurance by reducing the opportunity cost of precautionary saving. Buying insurance reduces one's need to engage in precautionary saving, which is most valuable to individuals without bequest motives who wish to consume all of their wealth. The results suggest that bequest motives significantly increase saving and significantly decrease purchases of long-term care insurance and annuities, especially by retirees in the top half of the wealth distribution.

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