• Working Paper

    • Don’t Ignore Inflation Ignorance: On the Relevance of Money Illusion for Economic Modeling (with N. Branger and H. Cordes)

      Abstract: Behavioral research on money illusion shows that investors tend to ignore inflation and focus on the nominal returns of their investment opportunities. Yet, economic modeling mostly disregards these findings and follows the standard paradigm in which investors base their decisions on real returns only. A possible reason for the disregard is that the degree of money illusion has not yet been quantified in a way that allows a well-founded discussion of the relevance for modeling. We conduct a rigorous investment experiment to close this gap. We find a substantial degree of money illusion in participant behavior and show that extending a standard model by a money illusion component can be vital to capture the observed behavior adequately. Our findings have far-reaching implications and call for a more prominent role of money illusion in economic modeling.

    • Misperception of Exponential Growth: Are People Aware of their Bias? (with H. Cordes and B. Foltice)

      Abstract: Exponential growth bias, the tendency to linearize exponential growth when assessing it intuitively, has been shown to have harmful effects on the consumers’ financial decisions. To guide policy-making in designing effective debiasing approaches, this study analyzes the individuals’ self-awareness of the bias and how it is shaped by its specific roots; arithmetic and conceptual problems. Arithmetic problems refer to computational errors that could easily be overcome by employing arithmetic assistance (like a calculator). Conceptual problems refer to a general misunderstanding of exponential growth. In an incentivized experiment, we find that participants strongly underestimate the magnitude of their bias. Interestingly, they simultaneously reveal a high willingness to pay for arithmetic assistance, which mitigates arithmetic problems but does not help with conceptual problems. The willingness to pay is vastly unrelated to the benefits provided by the assistance, indicating that participants have a vague understanding of their bias and the interplay of its roots. Instead, the high willingness to pay seems to reflect a general aversion against relying on the intuitive judgment when comparing it to the seemingly more knowledgable situation where the assistance is available.
    • An Experimental Analysis of Annuity Aversion (with S. Nolte)

      Abstract: To understand the factors that influence people in their retirement decisions is of great importance. Due to an ongoing shift in western societies from public to private pension systems it becomes more and more the task of individual retirees to insure against longevity risk. While economic theory suggests that annuities should account for large parts of a retiree’s income, only few retirees include private annuities in their retirement portfolio at all. Empirical data on what drives this annuity aversion is limited, so we suggest using laboratory experiments to test possible explanations for the low rates of annuitization. We propose an experimental setup and provide a possible framework for future experimental research in the context of annuities. In a first application, we use this framework to test the influence of framing and lifetime uncertainty on annuity aversion.2
    • Exponential Growth Bias Matters: Evidence and Implications for Financial Decision Making of College Students in the U.S.A. (with B. Foltice)

      Abstract: This paper tests the exponential growth bias of undergraduate students at a top-level university in the United States and explores the potential drivers that influence the size of this bias. We also evaluate the impact of this bias on the savings and debt decisions that have been already made by these university students. Here, we find that bias matters, even for college students, in making savings and debt decisions. In this sample, we observe that the individuals who have already taken on debt are more biased in their compound savings estimates, while those who have experience with savings products are less biased. Interestingly, we detect no significant differences in the results between freshmen and upperclassmen, despite the findings that significantly more upperclassmen claim to have previously learned about compounding interest and are more aware of compound growth. We believe that these findings entail some strong policy implications and we urge policy makers to consider both a more extensive compound savings formula training curriculum to the current Common Core State Standards Initiative coupled with a more experientially-based learning curriculum with a focus on bias “awareness” for these important savings and debt decisions.
    • Countering Money Illusion? How Personalization Affects the Consideration of Inflation in Consumer Financial Planning (with H. Cordes and C. Erner)

      Abstract: Financial institutions increasingly provide consumers with the opportunity to construct their personal inflation rate in the process of financial planning. As it can be expected that consumers perceive a personal inflation rate to be more relevant for their financial wellbeing than a general one, the provision of this service could counter their money illusion, the behavioral tendency to neglect the value-diminishing effects of inflation in financial planning. Contrary to this intuition, we find in a series of experiments that constructing a personal inflation rate reduces the consideration of inflation: The complexity of the personalization process reduces the subjective understanding of inflation and thereby the perceived competence in judging its effects properly. We conclude that the consumers’ perception of inflation is more nuanced than the naïve intuition predicts, and that current best practices of countering money illusion might have unintended consequences.
    • Do changes in reporting frequency really influence investors’ risk taking behavior? Myopic loss aversion revisited (with M. Weber and S. Zeisberger)

      Abstract: According to the behavioral concept of myopic loss aversion (MLA), investors are more willing to take risks if they are less frequently informed about their portfolio performance. This prediction of MLA has been confirmed in various experimental studies and the conclusion has been drawn that banks could in fact influence investors’ risk taking behavior by adjusting the frequency with which they give feedback. However, none of the existing studies has really provided an explicit test of this dynamic prediction. Instead it is simply assumed that the results from between-subject experiments translate to a within-subject scenario in which feedback frequency changes over time. To examine the scope of the phenomenon and to assess its practical relevance, we present the first experimental study of MLA that directly addresses the dynamic prediction and manipulates feedback frequency (and investment flexibility) within-subject. Our analysis reveals that the impact of such dynamic changes is not as straightforward as commonly assumed. Stickiness and a general introspection component superimpose the standard MLA effect and generate unexpected dynamic patterns of risk taking behavior.
    • Perceiving the Real Value – How Inflation Communication Affects the Attractiveness of Investing (with H. Cordes)

      Abstract: Ignoring the effects of inflation in retirement planning can have severe consequences for the financial wellbeing in old age. Therefore, it seems important to make private investors aware of the divergence between future nominal wealth and real purchasing power. Such information can be communicated in various ways, from vaguely pointing towards the concept of inflation to explicitly presenting future investment payoffs in real terms next to the standard nominal information. Using a novel experimental approach that mimics the divergence between nominal wealth and real purchasing power, we compare how different inflation communication approaches affect the attractiveness of long-term investments. The results are subtler than the naïve intuition predicts: Differences between the approaches strongly depend on whether the investment product offers a positive or negative real return. With interest rates currently being on historical lows, our findings carry important implications: The optimal inflation communication approach seems to depend on both the general interest rate in the economy and the risk-return properties of the specific investment product.
    • Biases in allocation under risk and uncertainty: Partition dependence, unit dependence, and procedure dependence (with C. Fox)

      Abstract: Previous studies of employee investment in retirement plans suggest that people typically "naively diversify" their investment funds, tending to allocate 1/n of the total to each of n available instruments (Benartzi & Thaler, 2001). In this paper we provide experimental evidence that this bias extends to allocation among simple chance prospects and demonstrate three new violations of rational choice theory implied by use of the naïve diversification strategy. Study 1 demonstrates “partition dependence” in which participants' allocations among a fixed set of investments varies with the hierarchical structure of the option set (e.g., by vendor and instrument). Study 2 demonstrates “unit dependence” in which participants' preferred allocations vary with the metric in which the investment is reported (dollars versus number of shares). Study 3 demonstrates “procedure dependence” in which the bias toward even allocation disappears if participants are asked to choose from a menu of possible portfolios. We show that these results extend to sophisticated participants, simple well-specified gambles and incentivecompatible payoffs. We close with a discussion of theoretical and prescriptive implications.
    • How to Decrease the Amortization Bias: Experience vs. Rules (with B. Foltice)

      Abstract: We conduct an experimental study that tests the effectiveness of de-biasing the amortization bias of 251 bachelor students at a German university through the use of short tutorials based on three different methods of learning: experiential learning, learning a simple “I Owe More” debt rule-of-thumb, as well as learning an extended, but more accurate version of the “I Owe More” rule.  Immediately after completing these 10-minute tutorials, we test for the amortization bias again and find a decreased bias for participants in all three treatments, with the group learning the extended rule showing the greatest initial improvement.  More importantly, after confronting the same participants with similar debt scenarios approximately three weeks later, those who learned the simple and complex rules of thumb tend to revert back to their biased answers, while the experiential learning group best retained their improvement in bias. We find evidence in this experiment that experience-based learning is best suited to produce a long-lasting improvement for attenuating the amortization bias.
    • Generally higher but not generally better: How subjective expertise affects estimation accuracy (with L. Rettig)

      Abstract: In a laboratory experiment, we investigate the effect of subjective expertise (i.e. confidence intervals and competence) on accuracy. The experimental task was to estimate quantities on a bounded [0;100] scale with either high or low true values. [...] In sum, our data suggest that higher competence does not lead to generally better, but generally higher estimates.
    • Does it pay to set up a prediction market? (with E. Diecidue and A. Jacobs)

      Abstract: Prediction Markets (PM) have been shown to consistently outperform consensus forecasts. Through the trading mechanism they do not only aggregate best guesses but also the strength of the beliefs. The improved prediction quality comes at the cost of organizational complexity, however. We experimentally investigate whether forecasts of similar quality could be generated by individually assessing best guesses, strength of beliefs, competence, and other variables, and applying appropriate aggregation schemes. We find PMs to be superior. [...]