Transcript Persuasion in Household Finance

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
evidence
– Sprinkled with related findings on savings
decisions
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
Decision-Making?
• 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
Findings:
Marketing Treatments
• Some “worked” (increased takeup), some
didn’t
• 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
prevalent?
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)….
1000
0
500
Frequency
1500
Stated Interest Rate
0
20
40
60
Mean=17, Median=18
80
100
600
400
0
200
Frequency
800
1000
Implied APR from Total Payments
0
20
40
60
Mean=57, Median=43
80
100
400
0
200
Frequency
600
800
Difference between Implied APR and Stated Rate
0
100
200
Mean=38, Median=25
300
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,
retailers)
– 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
numerate
• Key decisions are often low-frequency– little
opportunity for learning-by-doing, reinforcement
– Examples: car purchase (with loan), retirement plan
Problems with
Information-Provision
• “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
operations
• 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
Disseminate