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Essays on Decisions Involving Recurring Financial Events

Stephen Atlas, 2013
Faculty Advisor: Eric Johnson


This dissertation explores what influences consumer financial decisions with consequences that recur over time, such as mortgages and recurring payment plans in contracts. This dissertationinvestigates two questions: (1) How do individual differences in intertemporal preferences influence how consumers think about recurring financial events? (2) How does the aggregation level used to describe the recurring financial consequences impact how consumers mentally represent the purchase? Taken together, this dissertation explores how consumers mentally represent recurring outcomes and express these preferences through choice.

The first essay explores the relationship between individual differences in time preferences and decisions involving recurring payments in the domain of mortgage choices. It relates two components of an individual's time preference, a present bias (overvaluing immediate outcomes), and a personal discount rate (the exponential component of time preferences), to mortgage selection and the decision to strategically abandon a home worth less than its mortgage.

Combining insights from an analytic model and a survey of 244 mortgaged households augmented by zip-code market house price data, this essay proposes that consumers with greater present bias and exponential discounting are more likely to choose mortgages that minimize up-front costs and be underwater. This model also suggests that present bias decreases the likelihood of walking away, but that higher discounting increases that likelihood, a result consistent with the data. Time preferences remain robust predictors with individual and market-level controls, and alternate model specifications.

The second essay explores how the aggregation level of a recurring price (e.g. on a daily vs. a yearly basis) impacts how consumers mentally account for a contract's benefits. For example, if consumers are told the daily price of a car lease, they imagine the daily benefits of the car, and when they are told a monthly price they imagine their broader use of the car. This essay builds on the "pennies-a-day" model (Gourville 1998), which posits that narrowly framed recurring costs can increase a consumer's willingness to purchase by making the cost of a purchase seem trivial. The essay will present evidence that triviality is neither a necessary nor sufficient condition for narrow framing to increase willingness to purchase and expand the domain of situations where such narrow framing increases purchase. Five web-based experiments suggest that scope insensitivity plays an important role in this effect since under recurring costs, consumers repeatedly "book" the most valued units, while under one-time costs consumers tend to experience less return to scale.

Together, the two essays suggest that contracts involving recurring financial events are mentally represented differently from those with one-time financial events, and that content is then discounted based on intertemporal preferences.

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