UC Santa Barbara

This dissertation uses controlled experiments to understand why people fall shortof making rational decisions in simple financial decision-making situations, how we can restore rationality through simple interventions, and how providing people with substantial opportunities to learn about their environment might lead them away from making rational decisions.

In the first chapter, joint with Guangli Zhang, we study the sources of suboptimalallocations observed in credit card repayments using a diagnostic laboratory experiment. We find that optimization ability and limited attention are jointly insufficient to explain the puzzle. Moving beyond existing results, we find that the inherent negative frame of the debt payment problem interferes with subjects’ ability to optimize and hinders learning. We show that subjects predominantly rely on the irrelevant balance information while forming their decisions, regardless of how vividly the balance information is displayed. Using additional treatments, we find that the debt frame increases subjects’ focus on the irrelevant balance information.

In the second chapter, joint with Guangli Zhang, we study what type of interventionswould be effective in eliminating simple arbitrage failures in repayments. We construct a simple repayment environment in the laboratory and test the role of a set of behavioral mechanisms that would directly inform the design of consumer protection policies. We find that providing salient interest rate disclosure has no effect while disclosing the interest rate in a fee format has modest effects. On the other hand, providing an opportunity to purchase automated financial advice reveals that subjects are predominantly aware of their choice inefficiencies and are relatively good at gauging the extent of their mistakes and using financial advice. Our results suggest that promoting and subsidizing consumer financial technology applications that provide automated financial advice would be a substantially more effective way of protecting consumers from simple arbitrage failures than conventional disclosure policies.

In the final chapter, I study how people learn about their environment when theirsubjective understanding of the environment, their mental model, is misspecified. I use people’s tendency to hold optimistic beliefs about their abilities to generate a significant amount of model misspecification and investigate the implications of overconfidence as a misspecified mental model on learning about own ability and a fundamental. Consistent with the theoretical predictions, overconfident subjects develop pessimistic beliefs about the fundamental and take growingly suboptimal actions. Inconsistent with the theoretical predictions, I find endogenous feedback does not exacerbate the extent of suboptimal behavior. Investigating how subjects learn about their own ability reveals that abundant feedback ”weakens” misspecified mental models. The ”weakening” of mental models is more pronounced with endogenous feedback and explains why endogenous feedback may not exacerbate the extent of suboptimal behavior.