When misperception of wealth lead to financial crises

Alberto cardaci

Nationality Italian

Year of selection 2017

Institution Complexity Lab in Economics (CLE), Milan

Country Italy

Risk Socio-Economics

Post-Doctoral Fellowship

2 years

118000 €

Perception and reality don’t always match. Some of us are optimists, others pessimists. Our behaviours may not be consistent with the information that we have, and this also applies to our purchasing decisions. « Recent findings in behavioural economics show that differences in perceptions can modify individual behaviour in ways that have potentially relevant macroeconomic consequences », Dr. Alberto Cardaci reports. Drawing from these findings, the researcher in Economics aims to investigate whether misperception of wealth can alter the state of the economy. By adopting a different perspective on the causes of financial crises – the 2007 sub-prime crises in particular – his aim is to contribute to a better understanding of the mechanisms leading to massive accumulation of household debt and the following default cascade.

 « I first came out with the idea for this project after watching The Big Short. There is a scene in the movie in which a woman with a low-paid job explains how she possesses four appartements and lots of other property », Dr. Alberto Cardaci relates. « I was struck by the idea that a person in her situation could feel confident that they could afford all of these things ». « My intention is to study how these “cognitive biases” affect individual perceptions of wealth and, as a consequence, the decisions to consume and borrow. In other words, I want to understand how we come to deviate from rational judgement, what induces it, and how it leads individuals to make decisions that are inconsistent with the actual amount of available financial resources they have », he adds. « My ultimate goal is to investigate whether such individual behaviour can explain consumption booms and debt euphoria and pave the way for a financial collapse ».

 Financial literacy : are people equipped to make effective decisions with their money?

 The first part of his research will consist in a series of laboratory experiments designed to empirically test whether misperceptions of wealth actually lead individuals to spend more and to accumulate debt. « The first of these experiments is going to be about financial literacy, trying to figure out if cognitive biases come from people not being able to read their balance sheet properly », Dr. Alberto Cardaci specifies. The result of these experiments will also help identify a set of nudge policies to help offset the impact of such biases. « A nudge is any easy intervention “that alters people’s behavior in a predictable way without forbidding any options”, Dr Alberto Cardaci explains. « My set of nudges should include polices that, in principle, can be implemented by private companies, like banks, and public institutions since both can act as “choice architects” ». « The idea is to provide people information about the average level of borrowing in their reference group, which can be the neighbourhood, work colleagues, people who have a bank account at the same bank, and so on ». The second part of the research consists in the development of a computational model, that studies the macroeconomic consequences of individual decision-making with wealth misperceptions, and allows to simulate the set of experimentally tested nudge policies. « The inclusion of nudges and choice architecture techniques in a computational model represents an innovative approach for the study of the collective consequences of individual behavior ».

 Combining findings from behavioural economics and social cognitive psychology with the modern techniques of computational macroeconomics, Dr. Alberto Cardaci is adopting a different perspective on financial crises with respect to the existing literature. His findings will shed light on how financial stability can be jeopardized by the presence of cognitive biases that affect individual perceptions of wealth, and thus even if there are no notable changes in the fundamentals. In particular, by contributing to a better understanding of the causes of the recent financial crisis in the United States, the researcher and this team aim to avoid repeating the past.