July 26, 2013Ford Financial Products Innovation Fund

Working Group Meeting

Behavioral Design 101

Jonathan ZinmanDartmouth College and

IPA’s U.S. Household Finance Initiative

• Symptoms (focus on household finance)

• Diagnoses: what can go wrong (“behavioral factors”)

• Treatments

• Design principles for treatments

Outline

• Lots of borrowing (overborrowing?)

– Credit card debt per household ~= $10,000

– Student loan debt per household ~= $10,000

– Mortgages, auto loans

– Share of consumers with subprime credit: 56.4% 1

• Many without savings (undersaving?)

– Households with insufficient liquid assets to subsist for three months at the poverty line in absence of income: 43.9% 2

– Households that reported no saving in the previous year: 48% 3

• Many pay premia for financial services (overpaying?) 4

– Assets

– Loans

– Advice

Symptoms

Diagnosis: Struggles in Managing Desires

• Factor: Self-Control problems (carpe diem!)– Treatments: commitment, support, on-ramping

• Factor: Loss-aversion– Treatments: pre-commitment, change the frame

• Factor: Projection bias– Treatment: help people visualize the future

Diagnosis: Bandwidth Constraints

• Factor: “limited attention”

- Failing to consider contingencies

- Tuning out/not engaging

- Forgetting

• Treatments:

- Default options

- Pre-commitment

- Automation

- Reminders

Diagnosis: Biased Forecasting

• Many types:

- Factor: Belief in Law of Small Numbers

- Factor: Non-belief in Law of Large Numbers

- Factor: *Excessive optimism

• Treatment:

- Information/debiasing?

• Factor: Exponential Growth Bias- People underestimate growth and decline when interest compounds

Þ Saving appears less renumerative

Þ “Low monthly payments” appear deceptively cheap

• Treatments:- Saving: Show future values

- Borrowing: APRs and other apples-to-apples comparisons

• Factor: Low Numeracy

• Treatments: - Simple, intuitive information?

Diagnosis: Getting the math wrong (even whenthere’s little uncertainty)

• Factor: Low Financial literacy- Lack of basic knowledge

Of key concepts: diversification, inflation

Of how products work: e.g., ARMs, term vs. whole life

• Treatments: - Default options

- Simple/intuitive disclosures

Diagnosis: Getting the facts wrong

About finance, about oneself. Why?1. Limited opportunities

• On high-stakes decisions (mortgage, job, auto financing)• Even high-frequency decisions can have uncertain long-run

implications- Credit card use (what’s right debt load for me/my family)?

• Changing life circumstances creates moving targets2. Difficult subject matter3. Sensitive subject matter and motivated ignorance• Factor: Confirmation bias and other asymmetric learning

Diagnosis: limited learning

Delegation: works pretty well in medicine, auto repair, etc.

• But financial advice markets are a mess

- Questionable quality: Lots of biased, even fraudulent advice

- Limited scope: Who covers the household balance sheet?

- Limited coverage: mass market?

Competition: often brings prices down, but does not seem sufficient to eliminate yield-spread premia, $39 overdraft fees, etc.

Diagnosis: “Killer Apps” don’t work as well as in other markets

• Simplify

• Streamline (on-ramping)

• Just-in-time (reach people at decision point)

• Meet people where they’re at

– Facilitating, nudging much more effective than felt-change

• Diagnose and treat

• Be humble: we still have a lot to learn

– Mixed and limited evidence, especially outside the lab

– A premise of behavioral social science is that context matters

Developing Treatments:Design Principles

Jonathan Zinman

US Household Finance Initiative

Innovations for Poverty Action

www.poverty-action.org/ushouseholdfinance

www.dartmouth.edu/~jzinman/

jzinman@dartmouth.edu

Thank You!

Taxonomy of Behavioral Factors (see DellaVigna JEL)

DECISION

DECISION

Biases in preferences• Time-inconsistency• Loss aversion

Biases in expectations• Overconfidence• Over-optimism

Biases in price perceptions/valuation• Exponential growth bias• Anchoring

“Cross-cutting” biases/heuristics/ limitations:

Anchoring, Limited attention, Innumeracy

DECISIONPreferences

Biases/limitations in cognition that affect perceptions about how to maximize utility

subject to constraints(Affect other key parameters we might model:

expectations, prices, transaction costs…)

Alternate Taxonomy