9. Consumer Choices and Financial Decisions Flashcards
Mental accounting
The psychological process by which individuals record, summarise and analyse their finances in their heads
3 components of mental accounting
- How outcomes are perceived and experienced and how decisions are made and evaluated
- Assignment of activities to specific accounts
- Frequency with which accounts are evaluated
Comprehensive account
Take wealth, future earnings etc into account
Minimal account
Only examine differences between options
Topical account
Compare consequences
What experiment did Kahenman and Tversky create which proved people use topical accounting?
The one with a calculator and a jacket where people prefer to save £5 on a £15 calculator when also buying a £125 jacket then save £5 on a £125 calculator when buying a £15 jacket
Hedonic framing
How people try to maximise psychological pleasure and minimise pain when dealing with gains and losses
What are the four principles of hedonic framing?
- Segregate gains
- Integrate losses
- Integrate smaller loss with larger gain
- Segregate small gains from larger losses
Acquisition utility
Value of a good obtained relative to its price
Transaction utility
The difference between the smoking paid and the reference price of the good
How do the opening and closing of mental accounts affect trading stocks?
People are reluctant to realise losses snd too quick to realise gains. In other words they are preferring to sell a stock that has increased in value over time rather than selling a stock that has decreased in value
Sunk costs fallacy
Pursuing an inferior option because of previously investing non recoverable resources in the option
Escalating commitment
Continued commitment and increased allocation of resources to a failing course of action, often in the hope of recouping past losses associated with that course of action
Describe the sunk costs for self and others experiment
Imagine you have (paid £200/ won a free/ friend paid £200) for a ticket for a game that now has terrible weather conditions and you are unlikely to enjoy, do you go?
Results of sunk cost for self and others results
•highest attendance when you have paid, then when friend has paid, lowest if it’s free since there are no sunk costs
Choice bracketing
Where the notional boundaries between mental accounts fall affects decision making
Narrow bracketing
When each in a series of decisions will be approached differently depending on whether each is considered separately or the series is considered together
House money effect
Gamblers who win mentally open a gambling account to psychologically separate their own money and gambling money
What is the evidence of the label effect in UK winter fuel payments? (Beatty et al 2014)
- there is a jump in fuel use at 60 under the policy and there wasn’t before the policy
- compelling but not inclusive because not fully controlled
Describe the field experimental test of fungibillity (Abeler + Marklain 2017)
- in wine restaurant in Germany
- guests received €8 vouchers with two treatments and a baseline
- cash treatment: voucher could be spent on food and wine
- label treatment: voucher labelled “gourmet beverage voucher”
- baseline: no vouchers
Results of fungibility field experiment (Abeler and Marklain 2017)
Average spend didn’t increase with cash voucher but did increase with label voucher.
Only 22 observations for each and still not fully controlled
Describe the fungibility lab experiment
- Induced value “utility function” for housing and clothing
- baseline stage: cash budget 50 MU to allocate between housing and clothes, optimal consumption is (12,7)
- grant stage: 50MU plus housing grant of 30MU, optimal consumption is (13,20)
Results of of fungibility lab experiment
- baseline: consumption of housing close to optimum 12
- cash: consumption of housing just over optimum 13
- label: consumption of housing significantly higher than 13
- over 20% of people put all labelled grant to housing- zero fungibility
What is the equity premium puzzle?
The problem of why stocks give significantly better returns than bonds?
Myopic Loss Aversion (MLA)
The combination of loss aversion and mental accounting
What does bracketing when making financial decisions affect
- whether sets of transactions are evaluated as portfolios or individually
- how often portfolios are evaluated
How does MLA explain the equity premium puzzle?
Stocks may seem excessively risky when the investor exhibits MLA and viewed in high frequency therefore they yield higher returns
How do progressional traders compare to students in exhibiting MLA
They supposedly exhibit MLA at an even greater extent than the students
Efficient market hypothesis
Asset prices include all the relevant information available on the market
How does the data not support EMH?
There is greater variation in the price of stocks than the present discounted value which is inconsistent with the theory
Describe the counter cyclical risk aversion experiment
- participants are primed with either boom or bust
* they are asked if they want to invest in a risky asset which is dependent on a yellow ball being pulled from a box
Results of counter cyclical risk aversion experiment
- boom participants invested more than bust participants
* this holds under both risk and ambiguity
In the counter cyclical risk aversion experiment does experience matter?
•high literacy and frequent trading participants invested more but were still subject to counter cyclical risk aversion
What were the results of booms and busts impacting mood?
- booms lift moods and make people feel less fearful
- we don’t have the technology to say that booms and busts affecting moods is the causal factor in counter cyclical risk aversion
