Cognitive Abilities and Household Financial Decision Making

human-brain-clipart-brain-clipartIn this paper, presented at the Family Financial Security Symposium in April, 2010, Sumit Agarwal and Bhashkar Mazumder analyzed the impact of cognitive skills on two specific examples of consumer financial decisions where suboptimal behavior is well defined: first, the use of a credit card for a transaction after making a balance transfer on the account, and second, cases where individuals are penalized for inaccurate estimation of the value of one’s home on home equity loan or line of credit application.

Download Paper The authors matched individuals from the US military for whom they had detailed test scores from the Armed Services Vocational Aptitude Battery test (ASVAB), to administrative datasets of retail credit from a large financial institution.  The results show that consumers with higher overall composite test scores, and specifically those with higher math scores, are substantially less likely to make a financial mistake.  Importantly, no such effects are found for verbal or for most other component scores.  They also examined the effect of these mistakes on the consumer cost of credit (APR and fee) payments.  They showed that the matched sample is reasonably representative of both universes from which it is drawn.