Exponential Growth Bias and Household Finance

Abstract

Exponential growth bias is the pervasive tendency to linearize exponential functions when assessing them intuitively. We show that exponential bias can explain two systematic biases in household finance: the tendency to underestimate an interest rate given other loan terms, and the tendency to underestimate a future value given other investment terms. Bias matters empirically: More-biased households borrow more, save less, favor shorter maturities for debt and assets, and use and benefit more from financial advice, conditional on a rich set of household characteristics. There is little evidence that our measure of exponential growth bias merely proxies for broader financial sophistication.

Keywords: exponential growth, household finance, behavioral finance

JEL Classification: D1