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Earn More Tomorrow: Overconfidence, Income Expectations and Consumer Indebtedness

Author

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  • Antonia Grohmann
  • Lukas Menkhoff
  • Christoph Merkle
  • Renke Schmacker

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.

Suggested Citation

  • Antonia Grohmann & Lukas Menkhoff & Christoph Merkle & Renke Schmacker, 2023. "Earn More Tomorrow: Overconfidence, Income Expectations and Consumer Indebtedness," Discussion Papers of DIW Berlin 2065, DIW Berlin, German Institute for Economic Research.
    • Handle: RePEc:diw:diwwpp:dp2065
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    References listed on IDEAS

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    1. David Richter & Jürgen Schupp, 2012. "SOEP Innovation Sample (SOEP-IS): Description, Structure and Documentation," SOEPpapers on Multidisciplinary Panel Data Research 463, DIW Berlin, The German Socio-Economic Panel (SOEP).
    2. Merkle, Christoph & Weber, Martin, 2011. "True overconfidence: The inability of rational information processing to account for apparent overconfidence," Organizational Behavior and Human Decision Processes, Elsevier, vol. 116(2), pages 262-271.
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    Cited by:

    1. Friehe, Tim & Pannenberg, Markus, 2021. "Time preferences and overconfident beliefs: Evidence from germany," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 92(C).
    2. Niklas Gohl & Peter Haan & Claus Michelsen & Felix Weinhardt, 2022. "House Price Expectations," Discussion Papers of DIW Berlin 1994, DIW Berlin, German Institute for Economic Research.
    3. Gohl, Niklas & Haan, Peter & Michelsen, Claus & Weinhardt, Felix, 2022. "House Price Expectations," IZA Discussion Papers 15040, Institute of Labor Economics (IZA).

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    More about this item

    Keywords

    Debt; consumption; borrowing; overconfidence; income expectations;
    All these keywords.

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G40 - Financial Economics - - Behavioral Finance - - - General

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