Earn More Tomorrow: Overconfidence, Income Expectations and Consumer Indebtedness

Antonia Grohmann, Lukas Menkhoff, Christoph Merkle and Renke Schmacker

No 2065, Discussion Papers of DIW Berlin from DIW Berlin, German Institute for Economic Research

Abstract: This paper examines whether biased income expectations due to overconfidence lead to higher levels of debt-taking. We show suggestive evidence for a link between overconfidence and borrowing behavior in a representative survey of German households (GSOEP-IS). This motivates a laboratory experiment to study causality behind these effects. In two experiments, participants can purchase goods by borrowing against their future income. We exogenously manipulate overconfidence about income expectations by letting income depend on relative performance in hard and easy quiz tasks. In the main experiment, we successfully generate biased income expectations and show that participants with higher income expectations initially borrow more. Overconfident participants scale back their consumption after income feedback. However, they remain in higher debt at the end of the experiment, which has real financial consequences. In a robustness experiment, we rule out that over-borrowing is driven by low prices of goods. Even though the expected income manipulation works less well in this experiment, debt-taking behavior is very similar and correlates with income expectations and overconfidence.

Keywords: Debt; consumption; borrowing; overconfidence; income expectations (search for similar items in EconPapers)
JEL-codes: D14 D84 G40 (search for similar items in EconPapers)
Pages: 51, LI p.
Date: 2023
New Economics Papers: this item is included in nep-exp
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https://www.diw.de/documents/publikationen/73/diw_01.c.888984.de/dp2065.pdf (application/pdf)

Related works:
Working Paper: Earn More Tomorrow: Overconfident Income Expectations and Consumer Indebtedness (2019)
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