Abstract
ABSTRACTThe study of household finance is challenging because household behavior is difficult to measure, and households face constraints not captured by textbook models. Evidence on participation, diversification, and mortgage refinancing suggests that many households invest effectively, but a minority make significant mistakes. This minority appears to be poorer and less well educated than the majority of more successful investors. There is some evidence that households understand their own limitations and avoid financial strategies for which they feel unqualified. Some financial products involve a cross‐subsidy from naive to sophisticated households, and this can inhibit welfare‐improving financial innovation.
Highlights
A presidential address is a privileged opportunity to ask questions without answering them, and to suggest answers without proving them
Household asset demands are important in asset pricing too, but wealthy and risk-tolerant households have a disproportionate impact on equilibrium asset returns whereas household finance is more concerned with the behavior of typical households
Campbell and Cocco (2003) solve a numerical model of household mortgage choice and show that adjustable-rate mortgage (ARM) should be attractive to unconstrained households when inflation risk is large relative to real interest rate risk; they should be attractive to potentially borrowing-constrained households with low risk aversion; but they should be unattractive to risk-averse borrowing-constrained households, those that have high mortgage debt relative to their income
Summary
Positive household finance asks how households invest. This is a conceptually straightforward question, but it is hard to answer because the necessary data are hard to obtain. The problem of non-response can be mitigated by offering households the opportunity to state a range for asset holdings rather than giving a precise answer, possibly using follow-up questions to narrow the initially chosen range This approach has been used with considerable success in the Health and Retirement Survey, which offers an attractive alternative to the SCF for measuring the behavior of older households (Juster and Smith 1997, Juster, Smith, and Stafford 1999). This dataset affords the unique opportunity to analyze the financial behavior of the entire population of an industrialized country.
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