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Household Finance

Paper Session

Saturday, Jan. 7, 2017 1:00 PM – 3:00 PM

Sheraton Grand Chicago, Chicago Ballroom X
Hosted By: American Finance Association
  • Chair: Johannes Stroebel, New York University

Minimum Payments and Debt Paydown in Consumer Credit Cards

Benjamin Keys
,
University of Chicago
Jialan Wang
,
University of Illinois-Urbana-Champaign

Abstract

Using a dataset covering one quarter of the U.S. general-purpose credit card market,
we document that 29% of accounts regularly make payments at or near the minimum
payment. We exploit changes in issuers' minimum payment formulas to distinguish
between liquidity constraints and anchoring as explanations for the prevalence of
near-minimum payments. At least 10% of all accounts respond more to the for-
mula changes than expected based on liquidity constraints alone, representing a
lower bound on the role of anchoring. Using a back-of-envelope calculation, we esti-
mate that anchoring consumers would save at least $570 million per year in interest
charges if all issuers adopted the highest observed minimum payment formula in
our sample. Disclosures implemented by the CARD Act, an example of one poten-
tial policy solution to anchoring, resulted in fewer than 1% of accounts adopting
an alternative suggested payment. Our results show that the design and salience
of contract terms in credit products have signicant impacts on household balance
sheets.

Access to Credit and Stock Market Participation

Serhiy Kozak
,
University of Michigan
Denis Sosyura
,
University of Michigan

Abstract

We exploit staggered removals of interstate banking restrictions to identify the effect of access to credit on households’ stock market participation and asset allocation. Using micro data on retail brokerage accounts and proprietary data on personal credit histories, we document two effects of the loosening of credit constraints on households’ financial decisions. First, households enter the stock market by opening new brokerage accounts. Second, households increase their asset allocation to risky assets and reduce their allocation to cash, consistent with a lower need for precautionary savings. The effects are stronger for younger and more credit constrained investors. Overall, we establish one of the first direct links between access to credit and households’ investment decisions.

The Liquid Hand-to-Mouth: Evidence From Personal Finance Management Software

Arna Olafsson
,
Copenhagen Business School
Michaela Pagel
,
Columbia University

Abstract

We use a very accurate panel of all individual spending, income, balances, and credit limits from a financial aggregation app and document significant payday responses of spending to the arrival of both regular and irregular income. These payday responses are clean, robust, and homogeneous for all income and spending categories throughout the income distribution. Spending responses to income are typically explained by households' capital structures: households that hold little or no liquid wealth have to consume hand-to-mouth. However, we find that few individuals hold little or no liquidity and also document that liquidity holdings are much larger than predicted by state-of-the-art models explaining spending responses with liquidity constraints due to illiquid savings. Given that present liquidity constraints do not bind, we analyze whether individuals hold cash cushions to cope with future liquidity constraints. To that end, we analyze cash holding responses to income payments inspired by the corporate finance literature. However, we find that individuals' cash responses are consistent with standard models without illiquid savings and neither present nor future liquidity constraints being frequently binding. Because these models are inconsistent with payday responses, we feel that the evidence suggests the existence of households that spend heuristically and call those the "liquid hand-to-mouth."

The Misguided Beliefs of Financial Advisors

Juhani Linnainmaa
,
University of Chicago
Brian Melzer
,
Northwestern University
Alessandro Previtero
,
Indiana University

Abstract

A common view of retail finance is that conflicts of interest contribute to the high cost of advice. Using detailed data on financial advisors and their clients, however, we show that most advisors invest their personal portfolios just like they advise their clients. They trade frequently, prefer expensive, actively managed funds, chase returns, and under-diversify. Differences in advisors' beliefs affect not only their own investment choices, but also cause substantial variation in the quality and cost of their advice. Advisors do not hold expensive portfolios only to convince clients to do the same--their own performance would actually improve if they held exact copies of their clients' portfolios, and they trade similarly even after they leave the industry. These results suggest that many advisors offer well-meaning, but misguided, recommendations rather than self-serving ones. Policies aimed at resolving conflicts of interest between advisors and clients do not address this problem.
Discussant(s)
Andres Liberman
,
New York University
Andrew Hertzberg
,
Columbia University
Scott Baker
,
Northwestern University
Gregor Matvos
,
University of Chicago
JEL Classifications
  • G2 - Financial Institutions and Services