Working Papers

Financial Sophistication and Consumer Spending New Draft

Abstract: This paper examines how financial sophistication affects consumers’ spending response to changes in disposable income. Using account-level data, I construct and validate a new measure of financial sophistication based on avoidable credit and debit card mistakes. Financial sophistication correlates with higher account optimization, higher participation in risky asset markets, and higher rates of mortgage refinancing. I then measure the spending response to a predictable change in mortgage payments using a difference-in-differences methodology. Financially unsophisticated consumers display significant spending responses to a predictable decrease in disposable income, even when controlling for liquid assets and credit scores, counter to standard models with borrowing constraints. Guided by these results, I compare different economic mechanisms and find that financial sophistication correlates with higher savings rates and lower luxury consumption, suggesting cognitive or optimization frictions rather than credit constraints.

(Previously circulated as “The Costs of Financial Mistakes: Evidence from U.S. Consumers”)

Does Competition Reduce Racial Discrimination in Lending? 
Joint with Greg Buchak

Abstract: This paper examines whether increases in bank competition reduce discriminatory practices in mortgage lending. Lenders are significantly less likely to approve black applicants' loan applications despite facing similar credit risk. However, following the relaxation of interstate bank branching laws in the 1990s, increases in local lending competition reduced the approval differential between potential white and black borrowers by roughly one quarter. The reduction was driven both by incumbent lenders altering lending policies to avoid losing market share and by the entry of new banks. The results suggest strong complementarities between direct regulation and the competition mechanism. In particular, direct regulation is effective against large lenders where statistical proof problems are less severe, while competition provides incentives to smaller, harder to regulate lenders.

Sharing R&D Risk in Healthcare via FDA Hedges, NBER Working Paper No. 23344
Joint with Andrew W. LoTomas PhilipsonManita Singh, and Richard Thakor

Abstract: The high cost of capital for firms conducting medical research and development (R&D) has been partly attributed to the government risk facing investors in medical innovation. This risk slows down medical innovation because investors must be compensated for it. We analyze new and simple financial instruments, Food and Drug Administration (FDA) hedges, to allow medical R&D investors to better share the pipeline risk associated with FDA approval with broader capital markets. Using historical FDA approval data, we discuss the pricing of FDA hedges and mechanisms under which they can be traded and estimate issuer returns from offering them. Using various unique data sources, we find that FDA approval risk has a low correlation across drug classes as well as with other assets and the overall market. We argue that this zero-beta property of scientific FDA risk could be a main source of gains from trade between issuers of FDA hedges looking for diversified investments and developers looking to offload the FDA approval risk. We offer proof of concept of the feasibility of trading this type of pipeline risk by examining related securities issued around mergers and acquisitions activity in the drug industry. Overall, our argument is that, by allowing better risk sharing between those investing in medical innovation and capital markets more generally, FDA hedges could ultimately spur medical innovation and improve the health of patients.

Media: Marginal Revolution, Forbes, RAPS

Work in progress

Competing and Advertising for Financial Products: Evidence from Television Ads
Joint with Gregor Matvos and Amit Seru