Risk of Overindebtedness and Behavioural Factors

RISK TOLERANCE IN FINANCIAL DECISION MAKING, C. Lucarelli, G. Brighetti, eds., Palgrave Macmillan, 2010

19 Pages Posted: 5 Aug 2010

See all articles by Luisa Anderloni

Luisa Anderloni

University of Milan - DEAS

Daniela Vandone

University of Milan

Date Written: August 4, 2010

Abstract

The aim of this paper is to analyse the link between behaviour and overindebtedness and to shed light on the effectiveness of policy measures to tackle household financial fragility. Behaviour leading to overindebtedness is often put down to social and psychological factors that reduce an individual’s capacity to evaluate the consequences of his/her consumption and borrowing decisions. Such decisions may not be rational from a classic economic point of view. In fact individuals tend, on the one hand, to overestimate their capacity to manage domestic financial resources and, on the other hand, to underestimate the possibility of being affected by negative events. As a result, these individuals systematically underestimate the risk of not being able to meet their financial commitments. Furthermore, they overestimate the immediate benefits and undervalue the future costs; such behaviour leads to the decision to purchase, using debt if necessary, regardless of the effect this choice may have on the sustainability of future debt levels. The fact that overindebtedness may be caused by individuals’ irrational behaviour is relevant and has to be taken into account in order to devise appropriate measures to prevent or manage situations of financial difficulties and to evaluate their effectiveness. The empirical literature has shown how psychological factors have an impact on the effectiveness of policies adopted to prevent and manage financial difficulties arising from overindebtedness. Studies carried out within behavioural economics have also shown that individuals have little awareness of these psychological mechanisms. Indeed, individuals in financial difficulties tend to lay the blame on exogenous factors such as job or family difficulties, which reduce income level below expected. Rarely do individuals recognise that the causes for their difficulties lie principally – or at least also – with their inability to manage money and the decisions made regarding spending and indebtedness. Furthermore, many studies have shown how deviant behaviour patterns persist even when individuals are aware of the risks they face. Individuals’ incapacity to take corrective steps despite knowing the dangers of overindebtedness may have significant implication for designing effective policies to management situations of indebtedness that may become pathological.

Keywords: Households behavioural finance, Overindebtedness, Consumer credit

JEL Classification: G21

Suggested Citation

Anderloni, Luisa and Vandone, Daniela, Risk of Overindebtedness and Behavioural Factors (August 4, 2010). RISK TOLERANCE IN FINANCIAL DECISION MAKING, C. Lucarelli, G. Brighetti, eds., Palgrave Macmillan, 2010, Available at SSRN: https://ssrn.com/abstract=1653513 or http://dx.doi.org/10.2139/ssrn.1653513

Luisa Anderloni (Contact Author)

University of Milan - DEAS ( email )

Via Conservatorio, 7
Milan, 20122
Italy
+390250321546 (Phone)
+390250321505 (Fax)

Daniela Vandone

University of Milan ( email )

Via Festa del Perdono, 7
Milan, 20122
Italy

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