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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.

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Persuasion in household finance new evidence new applications

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
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
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
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
So How Test Importance of Psychology in an Economic Decision?

  • Design marketing “features” that are based on “what works” in lab experiments in psychology

  • Lender randomly assigns these marketing features in direct mail

  • Measure impact of marketing on loan demand (takeup decision)


Marketing features tested
Marketing Features Tested Decision?

  • 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
Findings: Decision?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
Study #2: “Fuzzy Math” Decision?

  • 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
Marketing Payments, Decision?not (loan) prices

  • The more things change the more they stay the same….


The Denver Post March 12, 1980 Decision?

La Prensa de Minnesota March 31-April 6, 2005.


Our explanation for this payment interest bias
Our Explanation for this: “Payment/Interest Bias” Decision?

  • 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
Payment-Interest Bias: Facts Decision?

  • 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
Payment-Interest Bias: Findings Decision?

  • 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
Related Policy Issues Decision?

  • 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
Practical Implications Decision?

What do in light of this type of evidence?

  • Problems with Traditional Approaches:

    • Education

    • Information

    • Prohibition

  • New Approaches


Problems with financial education
Problems with Decision?(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
Problems with Decision?Information-Provision

  • “Information” = disclosure, teaching decision heuristics

  • Problems:

    • “Information overload”

    • Resistance


Problems with prohibition
Problems with Prohibition Decision?

  • The usual economic costs, plus:

  • Underground markets may be even more “high-touch”, able to exploit biases


New research suggests and develops new approaches
New Research Suggests and Develops New Approaches Decision?

  • Product Presentation

  • Social Marketing

  • Product Development


New approaches to product presentation
New Approaches to Decision?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
New Approaches: Social Marketing Decision?

  • 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
New Approaches: Decision?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
New Approaches Require Decision?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
Closing Thought Decision?

  • 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
A Virtuous Cycle Decision?


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