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Exponential Growth Bias and Household Finance

Authors

  • VICTOR STANGO,

  • JONATHAN ZINMAN

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    • University of California-Davis, Dartmouth College. Thanks to Jonathan Bauchet for research assistance and to Bob Avery and Art Kennickell for discussions on the 1983 Survey of Consumer Finances. Thanks to Dan Benjamin; Andy Bernard; James Choi; Xavier Gabaix; Al Gustman; David Laibson; Anna Lusardi; Ted O'Donoghue; Jesse Shapiro; Jon Skinner; Doug Staiger; and seminar/conference participants at the Yale SOM Behavioral Science Conference; Kellogg; Cornell; UC Davis; Georgetown; IZA; SITE; the AEA Annual Meetings; the Federal Reserve Banks of Boston, Chicago, and Philadelphia; the Federal Reserve Board; the Federal Trade Commission; the University of Michigan Retirement Research Center; the Dartmouth Economics Department; and the Dartmouth Social Psychology Research Interest Group for comments. Special thanks to Chris Snyder for help with the math of exponential growth bias. Previous versions of this paper circulated under the titles “Fuzzy Math and Household Finance: Theory and Evidence,” and “The Price Is Not Right… .”


ABSTRACT

Exponential growth bias is the pervasive tendency to linearize exponential functions when assessing them intuitively. We show that exponential growth bias can explain two stylized facts in household finance: the tendency to underestimate an interest rate given other loan terms, and the tendency to underestimate a future value given other investment terms. Bias matters empirically: More-biased households borrow more, save less, favor shorter maturities, and use and benefit more from financial advice, conditional on a rich set of household characteristics. There is little evidence that our measure of exponential growth bias merely proxies for broader financial sophistication.

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