Earnings Misperceptions and Household Distress

Juan Sanchez and Stefan Song ()
Additional contact information
Stefan Song: https://economics.wustl.edu/people/yingrui-song

No 2025-030, Working Papers from Federal Reserve Bank of St. Louis

Abstract: Households learn whether income changes are temporary or persistent from their own paychecks. This paper develops a quantitative model of financial distress that incorporates this inference and estimates the extent to which households overweight recent outcomes—diagnostic expectations—using survey data on income beliefs. The model explains distress without assuming extreme impatience and aligns with the observed relationship between income and interest rates. Learning and diagnostic expectations account for about half of delinquencies and one-third of bankruptcies. Diagnostic expectations generate welfare losses equivalent to a 0.6% permanent reduction in consumption, and policies aimed at mitigating financial distress are more effective in the model with diagnostic expectations.

Keywords: income; learning; diagnostic expectation; financial distress; bankruptcy; delinquency (search for similar items in EconPapers)
JEL-codes: D14 D84 E21 G51 (search for similar items in EconPapers)
Pages: 53 pages
Date: 2025-10-24, Revised 2025-11-12
New Economics Papers: this item is included in nep-dge
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://doi.org/10.20955/wp.2025.030 Full text (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedlwp:101999

Ordering information: This working paper can be ordered from

DOI: 10.20955/wp.2025.030

Access Statistics for this paper

More papers in Working Papers from Federal Reserve Bank of St. Louis Contact information at EDIRC.
Bibliographic data for series maintained by Scott St. Louis ().