9. Consumer Choices and Financial Decisions

Question 1

Mental accounting

Answer 1

The psychological process by which individuals record, summarise and analyse their finances in their heads

Question 2

3 components of mental accounting

Answer 2

1. How outcomes are perceived and experienced and how decisions are made and evaluated
2. Assignment of activities to specific accounts
3. Frequency with which accounts are evaluated

Question 3

Comprehensive account

Answer 3

Take wealth, future earnings etc into account

Question 4

Minimal account

Answer 4

Only examine differences between options

Question 5

Topical account

Answer 5

Compare consequences

Question 6

What experiment did Kahenman and Tversky create which proved people use topical accounting?

Answer 6

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

Question 7

Hedonic framing

Answer 7

How people try to maximise psychological pleasure and minimise pain when dealing with gains and losses

Question 8

What are the four principles of hedonic framing?

Answer 8

1. Segregate gains
2. Integrate losses
3. Integrate smaller loss with larger gain
4. Segregate small gains from larger losses

Question 9

Acquisition utility

Answer 9

Value of a good obtained relative to its price

Question 10

Transaction utility

Answer 10

The difference between the smoking paid and the reference price of the good

Question 11

How do the opening and closing of mental accounts affect trading stocks?

Answer 11

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

Question 12

Sunk costs fallacy

Answer 12

Pursuing an inferior option because of previously investing non recoverable resources in the option

Question 13

Escalating commitment

Answer 13

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

Question 14

Describe the sunk costs for self and others experiment

Answer 14

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?

Question 15

Results of sunk cost for self and others results

Answer 15

•highest attendance when you have paid, then when friend has paid, lowest if it’s free since there are no sunk costs

Question 16

Choice bracketing

Answer 16

Where the notional boundaries between mental accounts fall affects decision making

Question 17

Narrow bracketing

Answer 17

When each in a series of decisions will be approached differently depending on whether each is considered separately or the series is considered together

Question 18

House money effect

Answer 18

Gamblers who win mentally open a gambling account to psychologically separate their own money and gambling money

Question 19

What is the evidence of the label effect in UK winter fuel payments? (Beatty et al 2014)

Answer 19

• 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

Question 20

Describe the field experimental test of fungibillity (Abeler + Marklain 2017)

Answer 20

• 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

Question 21

Results of fungibility field experiment (Abeler and Marklain 2017)

Answer 21

Average spend didn’t increase with cash voucher but did increase with label voucher.
Only 22 observations for each and still not fully controlled

Question 22

Describe the fungibility lab experiment

Answer 22

• 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)

Question 23

Results of of fungibility lab experiment

Answer 23

• 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

Question 24

What is the equity premium puzzle?

Answer 24

The problem of why stocks give significantly better returns than bonds?

Question 25

Myopic Loss Aversion (MLA)

Answer 25

The combination of loss aversion and mental accounting

Question 26

What does bracketing when making financial decisions affect

Answer 26

• whether sets of transactions are evaluated as portfolios or individually
• how often portfolios are evaluated

Question 27

How does MLA explain the equity premium puzzle?

Answer 27

Stocks may seem excessively risky when the investor exhibits MLA and viewed in high frequency therefore they yield higher returns

Question 28

How do progressional traders compare to students in exhibiting MLA

Answer 28

They supposedly exhibit MLA at an even greater extent than the students

Question 29

Efficient market hypothesis

Answer 29

Asset prices include all the relevant information available on the market

Question 30

How does the data not support EMH?

Answer 30

There is greater variation in the price of stocks than the present discounted value which is inconsistent with the theory

Question 31

Describe the counter cyclical risk aversion experiment

Answer 31

• 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

Question 32

Results of counter cyclical risk aversion experiment

Answer 32

• boom participants invested more than bust participants

* this holds under both risk and ambiguity

Question 33

In the counter cyclical risk aversion experiment does experience matter?

Answer 33

•high literacy and frequent trading participants invested more but were still subject to counter cyclical risk aversion

Question 34

What were the results of booms and busts impacting mood?

Answer 34

• 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