Week 9
Bounded rationality
Intro
• Agents make decisions that are rational within the limits of available information, mental
capabilities and time constraints
◦ This means that revealed preference may not re ect true preference
◦ They have varying levels of decision making ability (DMA) causing heterogeneity in decision
making quality (DMQ)
• The subset of all options that the consumer considers is called their consideration set
DMA and DMQ- Agarwal and Mazumber (2013)
Method
Looking at two examples of suboptimal nancial decisions:
• Balance transfer mistake
◦ When an individual transfers balance to a new card, outstanding debt has a lower ‘teaser’
rate during the grace period, where as new debt has a higher rate than on old card
◦ This means the optimal decision after transferring entire balance to new card is to only make
new purchases on old card
◦ Violations of this are a BT mistake, and changing to the optimal strategy is a eureka moment
• Rate-change mistake
◦ Individuals who apply for a home equity loan must estimate the value of their home and are
penalised with higher APR if it di ers from the bank’s estimate
◦ They then accept this rate rather than reapplying elsewhere
• Data from the US military qualifying test containing measure of cognitive skills, and data on which
of them committed these suboptimal nancial decisions
Results
BALANCEMANSFIRMISTAKE RATECHANGEMISTAKE
1s.dinc.inAFQtscorecauses
point
Percentage
effect on
22.824.1 At
18
ismonth time S
Prleurekamomentatto
moment
mistake
no Primatechange
Poverty impedes cognitive function- Mani et al (2012)
Laboratory studies
Shoppers at a mall were paid to participate, so sample included a large range of incomes
Bounded rationality
Intro
• Agents make decisions that are rational within the limits of available information, mental
capabilities and time constraints
◦ This means that revealed preference may not re ect true preference
◦ They have varying levels of decision making ability (DMA) causing heterogeneity in decision
making quality (DMQ)
• The subset of all options that the consumer considers is called their consideration set
DMA and DMQ- Agarwal and Mazumber (2013)
Method
Looking at two examples of suboptimal nancial decisions:
• Balance transfer mistake
◦ When an individual transfers balance to a new card, outstanding debt has a lower ‘teaser’
rate during the grace period, where as new debt has a higher rate than on old card
◦ This means the optimal decision after transferring entire balance to new card is to only make
new purchases on old card
◦ Violations of this are a BT mistake, and changing to the optimal strategy is a eureka moment
• Rate-change mistake
◦ Individuals who apply for a home equity loan must estimate the value of their home and are
penalised with higher APR if it di ers from the bank’s estimate
◦ They then accept this rate rather than reapplying elsewhere
• Data from the US military qualifying test containing measure of cognitive skills, and data on which
of them committed these suboptimal nancial decisions
Results
BALANCEMANSFIRMISTAKE RATECHANGEMISTAKE
1s.dinc.inAFQtscorecauses
point
Percentage
effect on
22.824.1 At
18
ismonth time S
Prleurekamomentatto
moment
mistake
no Primatechange
Poverty impedes cognitive function- Mani et al (2012)
Laboratory studies
Shoppers at a mall were paid to participate, so sample included a large range of incomes
