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Ideas Made to Matter
New initiative tracks the trends remaking consumer finance
Whether it’s artificial intelligence or the blockchain, financial technology continues to transform consumer finance. It’s changing the way we bank, pay for insurance, and even apply for mortgages.
“Consumers are facing more financial choices than ever due to increased access and innovation in lending, saving, advising, insurance, and other areas,” said an MIT Sloan professor of finance.
“People used to have to go to banks to shop for mortgages or credit cards, and their local bank would offer a very limited set of options,” said Parker, co-director of the MIT Golub Center for Finance and Policy. “Now people can check offers from hundreds of financial institutions online with dozens of different contracts, and financial institutions use personal data to target their individual characteristics.”
With these developments in mind, MIT Sloan recently launched the Consumer Finance Initiative, which will focus on the intersection of consumer finance and fintech innovations. Experts across household finance, fintech, crypto, savings and lending markets, and retirement will conduct research to identify best practices and monitor risks and regulations.
“Households are facing many new risks and increasing complexity in their financial product choices,” said MIT Sloan finance professor who co-directs the CFI with Parker.
The CFI will also provide funding for new projects and glean insights from novel data sets — which is crucial to staying on top of important trends.
“At the core of consumer finance research are new forms of data that allow researchers, but also market participants, to better model consumer financial behavior, such as transaction-level payment data or blockchain data and many others,” Schoar said.
Here are a few examples of MIT Sloan research that delves into these timely topics.
Decentralized finance promises free entry to financial markets. But is it safe?
Decentralized finance, in which cryptocurrency-backed transactions are executed in a pseudonymous nature without the oversight of banks, is often touted as a more inclusive alternative to traditional banking. However, analyses by Schoar and the London School of Economics’ Igor Makarov show that the reality of the ecosystem is very different from the ideal, and many challenges remain regarding consumer financial protection and transparency.
In “Blockchain Analysis of the Bitcoin Market” and “Cryptocurrencies and Decentralized Finance,” Schoar and co-author Makarov demystify the sector by building new algorithms to identify the main participants in the ecosystem. They document very high concentration in the ownership of cryptocurrencies but also in the capacity to validate transactions (that is, a concentration of miners and validators), which highlights the importance of large insiders.
Meanwhile, as trading in cryptocurrencies continues to grow rapidly among retail investors, Schoar and her co-authors found that investors trade crypto differently from stocks and gold, even though gold is considered to be a model for crypto investments. The researchers discuss these findings in “Are Cryptos Different? Evidence From Retail Trading,” which shows that investors who adopt a contrarian strategy when investing in stocks or gold use a momentum strategy with cryptocurrency and are willing to hold on to these assets even when there are large price swings.
Age isn’t the only factor to consider when saving for retirement
Longstanding wisdom argues that age should be the main factor in determining how much to save for retirement. But in “Simple Allocation Rules and Optimal Portfolio Choice Over the Lifecycle,” Parker and co-authors revisited this notion. The researchers made use of machine learning to validate the old rules of thumb used for portfolio allocation and to design improved retirement savings vehicles.
This machine learning method incorporates age along with a host of other factors — such as a person’s medical costs, mortality risk, and taxes — and concludes that differences in wealth levels, the state of the business cycle, and dividend price ratios cause the largest differences in optimal portfolios at a given age.
Automatic enrollment in retirement plans doesn’t always boost long-term wealth
Automatic enrollment in retirement plans is often the default option at many companies; employers enroll employees unless they opt out. But does doing so actually increase lifetime wealth accumulation and welfare?
In “Default Options and Retirement Saving Dynamics,” MIT Sloan assistant professor of finance finds that the long-term effect of auto-enrollment is negligible — except for the lowest earners, for whom auto-enrollment increases total wealth at retirement by more than 12%.
In addition, not all is lost for those who don’t enroll automatically. They can compensate for not contributing early by allocating more to retirement plans later.
The US retirement system amplifies racial inequality
When it comes to saving for retirement, the old adage “It takes money to make money” doesn’t exactly bode well for low-income households.
In “Who Benefits From Retirement Saving Incentives in the U.S.? Evidence on Racial Gaps in Retirement Wealth Accumulation,” Choukhmane and co-authors find large gaps in retirement saving across racial groups, with white workers contributing at least 40% more to retirement plans than Black and Hispanic workers. The researchers hypothesize that poorer people don’t take advantage of the generous rates of return in retirement products because they have less money to start with.
What role do our beliefs play in investing and in saving?
How did the 2016 presidential election change investment behavior among Democrats and Republicans? In “Belief Disagreement and Election Choice,” Parker, Schoar, and their co-authors found that investors adjusted their portfolios differently in response to the election: Republicans rebalanced their portfolios toward equity, while Democrats rebalanced into safe assets over a six-to-nine-month time frame following the election.
Meanwhile, a study of consumer savings accounts found that people were hesitant to switch from one provider to another, even when helpful disclosures were included about comparable-product interest rates and clear information was provided on how to switch. Inconvenience, price insensitivity, and pessimistic beliefs all contributed to consumers’ hesitance, MIT Sloan professor and co-authors concluded in “Testing the Effectiveness of Consumer Financial Disclosure: Experimental Evidence from Savings Accounts.”
How do people invest amid uncertainty? Palmer further explores the role of investors’ beliefs in “Are Stated Expectations Actual Beliefs? New Evidence for the Beliefs Channel of Investment Demand,” with co-author Haoyang Liu. The two found that investors rely on their memory of past returns — because the past is certain — when making real-estate investing decisions and not on their own forecasts of home price growth, which are more uncertain.
Read next: MIT Sloan research on finance and investing