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					Persuasion in Household Finance:
New Evidence, New Applications
                 Jonathan Zinman
              Department of Economics
                Dartmouth College

          Federal Reserve Bank of Boston
        Consumer Protection Week Conference
                  March 29, 2006
           Plan for the Talk
• Two new pieces of evidence showing that
  persuasion has strong effects on
  consumer borrowing decisions
• Practical implications of this type of
  – Sprinkled with related findings on savings
Study #1: What Psychology Worth?
By: Bertrand-Karlan-Mullainathan-Shafir-Zinman
• Researchers worked with large consumer lender
  in South Africa to send direct mail:
  – To former, experienced clients
  – With randomized interest rates
     • Very expensive (200% APR), short-term (4-month) loans
     • Market looks like a cross between payday loans and old
       small loan/finance company personal loan market
  – With randomized presentations of substantively
    identical offers….
 What Drives Consumer Financial
• Say you got this letter…. what might drive
  whether you take a loan or not?
  – Economics says: price
  – Psychology says: price and lots of
    “contextual” factors
     • Mood (emotions)
     • Complexity of decision (so some presentations
       more effective/salient than others)
     • Firms often refer to this as “value-based” features
 So How Test Importance of Psychology in
        an Economic Decision?
1. Design marketing “features” that are
   based on “what works” in lab
   experiments in psychology
2. Lender randomly assigns these
   marketing features in direct mail
3. Measure impact of marketing on loan
   demand (takeup decision)
      Marketing Features Tested
• Table size (information overload)
• Comparison to competitor (gain-loss)
• Photo (cue)
  – Race (mis)match
  – Gender (mis)match
• Promotional giveaway (“congruence” frame)
• Suggestions
  – Priming call
  – Loan use
         Marketing Treatments
• Some “worked” (increased takeup), some
• When work, marketing effects very large
• On average, marketing effects very large
  – Effective marketing increases loan demand as
    much as a 20-30% drop in the interest rate
• Effective marketing dulled price sensitivity
      Study #2: “Fuzzy Math”
• Stango & Zinman project studying a
  particular, prevalent cognitive bias and its
  impacts on financial decisions & markets
• Motivation…. do you ever wonder why
  “monthly payments” marketing is so
        Marketing Payments,
          not (loan) prices
• The more things change the more they
  stay the same….
The Denver Post March 12, 1980   La Prensa de Minnesota March 31-April 6, 2005.
       Our Explanation for this:
       “Payment/Interest Bias”
• Give consumers all other loan terms but
  NOT the interest rate, and they
  systematically and dramatically
  UNDERESTIMATE the interest rate
  associated with a loan (offer)….
  Payment-Interest Bias: Facts
• First documented in 1960s and 1970s
  – Early finding impetus for Truth-in-Lending
• But largely ignored by social scientists
  since early 1980s
  – So most recent data is 1983
• Stango & Zinman first to systematically
  explore possible impacts of this bias on
  decision-making, the functioning of
  financial markets
Payment-Interest Bias: Findings
• Conditional on a rich set of household characteristics
  and/or loan characteristics, biased consumers are:
   – Less likely to comparison shop for loans
   – More likely to shop on non-price terms
   – More likely to have financed a recent large purchase
   – More likely to borrow from nonbank lenders (finance companies,
   – More likely to pay higher interest rates when borrowing from
     nonbank lenders
       • Some evidence that consumers are less price sensitive when
         borrowing from nonbank lenders
   – Less likely to have saved in the past year
   – And they have much less wealth
         Related Policy Issues
• Disclosure
• “Predatory Lending”
• Our findings echo stylized facts:
   – Violations (still) prevalent, and incredibly so in our
     sample period (Fortney 1986)
   – Non-bank lenders much more likely to be prosecuted
     (GAO 2004)
   – These lenders use marketing techniques that
     highlight monthly payments and obscure true
     borrowing costs
       Practical Implications
What do in light of this type of evidence?
1. Problems with Traditional Approaches:
  – Education
  – Information
  – Prohibition
2. New Approaches
               Problems with
           (Financial) Education
• “Education” = teaching problem-solving skills
• Decisions are complex
• Biases are prevalent, may be deep
  – Lack of numeracy
     • E.g., payment-interest bias incredibly widespread
  – Lack of comfort with numbers, finance even among
• Key decisions are often low-frequency– little
  opportunity for learning-by-doing, reinforcement
  – Examples: car purchase (with loan), retirement plan
             Problems with
• “Information” = disclosure, teaching
  decision heuristics
• Problems:
  – “Information overload”
  – Resistance
    Problems with Prohibition
• The usual economic costs, plus:
• Underground markets may be even more
  “high-touch”, able to exploit biases
   New Research Suggests and
    Develops New Approaches
1. Product Presentation
2. Social Marketing
3. Product Development
             New Approaches to
             Product Presentation
• Not fancy marketing, but….
• “Optimizing defaults”:
   – switching 401k defaults from “don’t participate” to “participate”
     has huge impacts on savings, even when there is a clear opt-out
     (Madrian and Shea; Laibson and co-authors)
   – showing a different example loan maturity has huge effect on
     maturity chosen (Karlan & Zinman 2005)
• Concise is nice: beware of information overload
   – BKMSZ on loans
   – Iyengar et al on savings
• Mental accounting and goal-setting (Karlan,
  Mullainathan, and Zinman ongoing)
New Approaches: Social Marketing
• Use marketing to spur more deliberate
  (better?) decisions
  – What’s good for the (rapacious corporate?)
    goose is good for the (benevolent?) gander
• Examples:
  – Punam Keller on mammograms: appeal to
    family rather than self
  – Karlan-Mullainathan-Shafir-Zinman: designing
    marketing approaches to encourage saving
          New Approaches:
        Product Development
• Can we stop consumers from borrowing
  too much? Don’t know yet.
• But we can help them save more….
• Economists have developed 2 successful
  “commitment savings” products motivated
  by evidence from psych and econ:
  – SMART: Thaler and Benartzi (2004)
  – SEED: Ashraf, Karlan, and Yin (2006)
           New Approaches Require
             Process Innovation
• Psychologically-driven interventions inherently
  require continued testing and fine-tuning
  – Lack of general psych theory
  – Importance of particular contexts
• Sophisticated firms (credit card companies,
  Amazon) have recognized this, built
  randomized-control evaluation of pricing and
  marketing strategies into their day-to-day
• Academics are now working in partnership with
  smaller firms, NGOs, and public agencies to
  bring these tools to the masses
              Closing Thought
• Evaluate:
  – is what you (or your grantees) are doing effective?
  – do a “gold-standard” (randomized-control) evaluation
    whenever possible
  – get outside (academic) help
• Innovate
  – again, collaborations w/researchers can be productive
• Disseminate
 A Virtuous Cycle

Evaluate                 Innovate