Bounded Rationality and Use of Alternative Financial Services

Abstract

The increasing pervasiveness of high-cost alternative financial services (AFS) has captured the attention of policymakers, consumer educators, and financial counselors. Using data from the 2009 to 2012 waves of the National Financial Capability Study (NFCS), this article investigates AFS borrowing behaviors through the lens of a boundedly rational choice framework, with an emphasis on overconfidence. Through repeated testing of isolated samples of individuals with characteristics that make them less likely to objectively need such products, the roles of actual (objective) and perceived (subjective) financial knowledge in the decision-making process are explored. Consistent results indicate that individuals with lower objective financial knowledge and those that are overconfident in their self-assessed knowledge level are significantly more likely to utilize AFS instruments. These results suggest that a significant portion of AFS users may select these products without conducting adequate search, resulting in less than optimal financial decisions holding all else equal.

The Influence of Financial Well‐Being on Pawnshop Use

“…In contrast, the odds that someone with greater subjective financial knowledge would use a pawnshop were 1.35 times higher than for someone with lower subjective financial knowledge. This is consistent with the results in Robb et al (). In the final model (Table ), those with greater financial well‐being were 16% less likely to use a pawnshop than those with lower financial well‐being.…”

“…As in previous research (Robb et al ), those who were overconfident in their financial knowledge were much more likely to use pawnshops than their counterparts. Greater subjective financial knowledge was associated with greater odds of pawnshop use while greater objective knowledge was associated with lower odds.…”

“…Lusardi et al (), Lusardi and Scheresberg (), and Robb et al () examined the influence of financial education and/or knowledge on use of Alternative Financial Services (AFS). Lusardi, Schneider, and Tufano concluded that pawnshop use was positively associated with having some financial education, a result contradictory to what would be expected but unexplained by the authors.…”

Who Uses Alternative Financial Services? A Latent Class Analysis of Consumer Financial Knowledge and Behavior

“…Compared to the Financially Thriving, this group is more likely to be younger, unmarried, lower income, and non-White. This group may struggle with overconfidence in their self-assessed knowledge level and use AFS without conducting adequate search for appropriate products, resulting in less than optimal financial decisions (Robb et al, 2015). Given the lack of strong relationship between financial knowledge and AFS use, and the fact that many AFS users otherwise exhibit financially healthy behaviors, policy makers must consider addressing the challenges of AFS for more than just the financially vulnerable-AFS users also include those who are banked, possess some financial knowledge, and exhibit other financially healthy behaviors.…”

“…For example, the most common locations for using AFS transaction products and services are liquor, grocery, convenience, and drug stores (Federal Deposit Insurance Corporation, 2014). At the individual level, lower financial knowledge and education (Robb, Barbiarz, Woodyard, & Seay, 2015;Seay & Robb, 2013;Stearns, Borna, & White, 2006), less education (Gross, Hogarth, Manohar, & Gallegos, 2012), and lower income and age (Theodos et al, 2010) are associated with AFS use. In addition, those who are unbanked, the unbanked who were previously banked, African Americans and Latinos, noncitizens, the unemployed, unmarried females, the middle aged (35-42 years old), those from larger households, and nonhomeowners are generally more likely to use AFS (Federal Deposit Insurance Corporation, 2012Gross et al, 2012;Munoz et al, 2015).…”