Pitfalls of compound interest effect: Private investors underestimate loss risks of financial products

People are investing their life savings in financial products, for instance, to provide for their retirement, and in doing so they are making their future financial situation almost entirely dependent on the success of these investments. The financial sector promotes numerous investment opportunities with widely varying levels of risk - from the classic private pension insurance to high-risk equity funds. To assist investors in selecting a product suitable for them and to safeguard against financial losses, policy-makers have prescribed standardized and comprehensible product leaflets and consulting protocols. But is that enough? In order to prevent investors from making poor investment decisions, they also need sufficient knowledge of the financial issues, which, for example, allow them to accurately assess the effects of compound interest on an investment and the risk of loss. This seems to be the problem area, as indicated by the results of a behavioral experiment conducted by DIW Berlin in cooperation with Humboldt-University Berlin: most of the participants chosen misunderstood the effect of compound interest - and therefore seriously underestimated the investment risk

Measuring Applicant Quality to Detect Discrimination In Peer-to-Peer Lending

We measure the quality of applications for online peer-to-peer lending in Germany and relate it to gender discrimination. The data context allows summarizing application quality as a single numeric measure, the expected internal rate of return. The measure serves as a control variable and is interacted with the applicants' gender. We find that women enjoy higher funding rates than men, mainly because they are less punished when they offer a low application quality. The evidence is consistent with the hypothesis that the predominantly male lenders have a less precise understanding of women's applications than of men's applications

Hidden Skewness: On the Difficulty of Multiplicative Compounding Under Random Shocks

Multiplicative growth processes that are subject to random shocks often have a skewed distribution of outcomes. In a number of incentivized laboratory experiments we show that a large majority of participants either strongly underestimate skewness or ignore it completely. Participants misperceive the outcome distribution’s spread to be far too narrow-band and they estimate the median to lie too close to the distribution’s center. The observed bias in expectations is irrespective to risk preferences and fairly robust to feedback. It is consistent with a behavioral model in which geometric growth is confused with linear growth. The misperception is a possible explanation of investors’ difficulties with real-world financial products like leveraged ETFs

Essays in Behavioral Economics and Econometrics

Der verhaltensökonomischen Literatur entsprechend behandeln die drei Kapitel dieser Dissertation unterschiedliche Aspekte des menschlichen Verhaltens, welches als "nicht-rational" zu bezeichnen ist. Jedes dieser Kapitel leistet einen Beitrag zum aktuellen Stand der Forschung auf dem Gebiet der Verhaltensökonomik mit Hilfe von entweder experimentellen, empirischen oder methodischen Ansätzen. Das erste Kapitel schlägt ein einfaches verhaltensökonomisches Modell vor und unterzieht dieses einer Reihe von experimentellen Tests. Das Modell erweitert die Literatur zur Fehlwahrnehmung von multiplikativen Wachstumsprozessen und hilft somit typische Fehlinvestitionen in der langen Frist zu erklären. Im Rahmen des zweiten Kapitels werden Daten einer Online-Kreditbörse genutzt, um empirisch zu untersuchen, ob sich private Investoren entsprechend den Vorhersagen der standardmäßigen ökonomischen Fachliteratur verhalten und einzig die erwartete Rendite berücksichtigen oder ob sie von anderen nicht-finanztechnischen Attributen eines Schuldners beeinflusst werden. Der Schwerpunkt der Analyse liegt dabei auf Geschlechterdiskriminierung im Rahmen dessen unterschiedliche Diskriminierungskonzepte getestet werden. Das dritte Kapitel wählt einen methodischen Ansatz und schlägt ein innovatives Experiment-Design vor, welches den empirisch gut dokumentierten Schwierigkeiten bzgl. der Angabe von subjektiven Wahrscheinlichkeiten von Teilnehmern an Umfragen und Laborexperimenten Rechnung trägt. Ein Binary-Choice-Ansatz eingebettet in ein adaptives Experiment-Design minimiert den Aufwand für die Befragten und ermöglich somit eine praktikable und effiziente Elizitierung der subjektiven Meinungen.In the line with the literature on behavioral economics, the three chapters of this dissertation shed light on different aspects of human behavior that are at odds with rationality. Each chapter contributes to the existing behavioral economic research using either experimental, empirical, or methodological tools. First, by proposing and experimentally testing a simple behavioral model that extends the literature on the misperception of multiplicative growth processes, Chapter 1 aims to explain common money mistakes that people often make with long-term investments such as retirement savings plans. Second, in Chapter 2, real-life investment data of an online-lending platform are used to empirically investigate if private investors behave as the standard economic literature would predict and solely consider an investment’s expected return or if they also care about other non-financial attributes of a debtor. The focus of the analysis is on gender discrimination, thereby defining and econometrically testing different concepts of how investors discriminate between male and female borrowers. Third, Chapter 3 takes a methodological path and proposes a novel experimental design that accounts for the empirically well-documented difficulties that survey respondents typically have when asked to state subjective probabilities. A binary choice approach embedded in an adaptive experimental design helps to minimize effort of the respondents, thus allowing for a more practical belief elicitation in both the lab and the field

Die Tücken des Zinseszinseffekts: Privatanleger unterschätzen Verlustrisiken bei Finanzprodukten

Legen Menschen ihre Ersparnisse in Finanzprodukte an, etwa um für ihr Alter vorzusorgen, machen sie davon in nicht unerheblichem Ausmaß ihre künftige finanzielle Lebenslage abhängig. Die Finanzbranche bewirbt zahlreiche und hinsichtlich ihres Verlustrisikos stark variierende Anlagemöglichkeiten - von der klassischen privaten Rentenversicherung bis hin zum hochriskanten Aktienfonds. Um die Anleger bei der Auswahl eines für sie geeigneten Produkts zu unterstützen und vor finanziellen Schäden zu bewahren, hat die Politik standardisierte und verständliche Produktinformationsblätter und Beratungsprotokolle vorgeschrieben. Doch reicht das aus? Damit Anleger ihr Geld nicht fehlinvestieren, benötigen sie nämlich auch ausreichende Kenntnisse bei Finanzthemen, die es ihnen beispielsweise erlauben, die Wirkungen des Zinseszinses und das Verlustrisiko einer Anlage korrekt einzuschätzen. An dieser Stelle scheint es zu hapern, wie die Ergebnisse eines Verhaltensexperiments des DIW Berlin in Kooperation mit der Humboldt-Universität Berlin vermuten lassen: Die ausgewählten Teilnehmer haben den Zinseszinseffekt mehrheitlich missverstanden - und das Anlagerisiko folglich massiv unterschätzt.People are investing their life savings in financial products, for instance, to provide for their retirement, and in doing so they are making their future financial situation almost entirely dependent on the success of these investments. The financial sector promotes numerous investment opportunities with widely varying levels of risk - from the classic private pension insurance to high-risk equity funds. To assist investors in selecting a product suitable for them and to safeguard against financial losses, policy-makers have prescribed standardized and comprehensible product leaflets and consulting protocols. But is that enough? In order to prevent investors from making poor investment decisions, they also need sufficient knowledge of the financial issues, which, for example, allow them to accurately assess the effects of compound interest on an investment and the risk of loss. This seems to be the problem area, as indicated by the results of a behavioral experiment conducted by DIW Berlin in cooperation with Humboldt-University Berlin: most of the participants chosen misunderstood the effect of compound interest - and therefore seriously underestimated the investment risk