Financial Homo Ignorans: measuring vulnerability to behavioral biases in household finance

Abstract

Understanding systematic differences in sound financial behavior between individuals is a key area for public policy and the possibility to tailor interventions to promote financial well-being. In this paper we develop and validate a concise 12 item questionnaire measuring individual’s vulnerability to behavioral biases in household finance – the Financial Homo Ignorans (FHI) Scale. We conduct two studies with general population samples (total N=2508) and show that the FHI scale can predict behavior in financial tasks such as consumer purchases, loan choices, or investment decisions, also when controlling for demographics, financial literacy and other related constructs. In addition, we show that consumer heterogeneity as assessed by the FHI scale explains the variation in household finance management and financial well-being. The FHI scale has application potential as it can be used by researchers, policy makers, and financial institutions to study the psychological underpinnings of financial behavior and design interventions by targeting individuals who are particularly vulnerable.

Financial well-being, COVID-19, and the financial better-than-average-effect

“…We measured financial ignorance using the Financial Homo Ignorans (FHI) scale (Barrafrem et al, 2020). Individuals were asked to state to what degree they agreed with a series of 12 statements on a scale from one to five.…”

“…Previous research has identified multiple factors that affect financial well-being. Some of them include: (1) social and economic environment like macro-economic context, family wealth, access to education, and geographic location (Brüggen et al, 2017); (2) objective and subjective financial knowledge (Joo and Grable, 2004;Lind et al, 2020) (3) trait self-control (Strömbäck et al, 2020); and (4) information avoidance and financial ignorance (Barrafrem et al, 2020). The COVID-19 pandemic is having a great impact on the world's economic situation and thus constitutes a non-negligible part of the prevailing economic context.…”

“…Previous studies have shown that investors tend to ignore the status of their investment portfolio during the market downturns, a phenomenon that has been dubbed the ostrich effect (Karlsson et al, 2009). We define financial ignorance as a tendency to neglect and avoid relevant financial information that is freely available (Barrafrem et al, 2020). For example, individuals may deliberately avoid available information (e.g., about the penalties for rolling over debts), ignore facts that are incongruent with their hopes and beliefs (e.g., what impact will the crisis have on global economy), ignore how multiple small outcomes add up to substantial sums (e.g., how paying off only the minimum on a credit card accrues substantial interest charges), or ignore making decision at all.…”

Competence, Confidence, and Gender: The Role of Objective and Subjective Financial Knowledge in Household Finance

“…Similarly, Allgood and Walstad (2013) found that subjective financial knowledge was a stronger predictor of less costly practices in credit card use than objective financial knowledge. A possible mechanism is that people with high financial confidence might be less reluctant to avoid financial information, which could affect behavior (Barrafrem et al 2020). Beliefs about the extent of one's own knowledge might thus be as important (or more) as actual knowledge when it comes to sound financial behavior.…”

Financial well-being, COVID-19, and the financial better-than-average-effect

“…Previous research has identified multiple factors that affect financial well-being; Some of them include: 1) social and economic environment like macro-economic context, family wealth, access to education, and geographic location (Brüggen, Hogreve, Holmlund, Kabadayi, & Löfgren, 2017) 2) objective and subjective financial knowledge (Joo & Grable, 2004;Lind et al, 2020); and 3) psychological factors (Barrafrem, Västfjäll, & Tinghög, 2020;Strömbäck, Lind, Skagerlund, Västfjäll, & Tinghög, 2017).…”