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Track T8-1: Return Expectations of Households and Professionals
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Presentations | ||
Microfounding Household Debt Cycles with Extrapolative Expectations 1Georgetown University; 2University of Chicago; 3UCL Combining transaction-level data with survey-based information from a large consumer panel, we show that on average consumers form excessively high expectations about future income relative to ex-post realizations after unexpected positive income shocks. This systematic bias in expectations leads to higher current consumption and debt accumulation as well as a higher likelihood of subsequent default on consumer debt. A consumption-saving model with defaultable unsecured debt and diagnostic Kalman filtering with consumers who over-extrapolate income shocks rationalizes these findings. The model predicts excessive leverage and higher subsequent default rates compared to a rational expectations benchmark. Over-extrapolation of income expectations can contribute to explaining state-dependent household debt cycles.
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