What Could Possibly Go Wrong? Predictable Misallocation in Simple Debt Repayment Experiments

Abstract

How do borrowers repay their debts? In two simple debt repayment experiments, we not only elicit different types of severe deviations from optimal, i.e. debt minimizing, repayment decisions. We rather show how these deviations can be triggered using supposedly irrelevant information and find evidence for a novel heuristic, the “Cuckoo Fallacy”, which is based on the amount of new debt rather than the interest rate. We also demonstrate that simple framing can decrease repayment misallocation, nudging borrowers to more optimal behavior. Our results inform scholars and policy makers on how to improve household’s financial decisions.

Keywords: Rationality, Bias, Cuckoo Fallacy, Financial Literacy, Experimental Finance

JEL Classification: D14, D80, D90, G40, G51, G53