Monday, January 7, 2013

Cognitive Capacity and Decision Making

There are several new papers assessing the link between cognitive ability to decision making.

Sumit Agarwal and Bhashkar Mazumder have a paper that just came out in the recent issue of American Economic Journal: Applied Economics, 2013, 5(1): 193–207 on "Cognitive Abilities and Household Financial Decision Making". The abstract reads:
"We analyze the effects of cognitive abilities on two examples of consumer financial decisions where suboptimal behavior is well defined.  The first example features the optimal use of credit cards for convenience transactions after a balance transfer and the second involves  a financial mistake on a home equity loan application. We find that  consumers with higher overall test scores, and specifically those with  higher math scores, are substantially less likely to make a financial mistake. These mistakes are generally not associated with nonmath  test scores."

They use "all active duty military personnel in 1993 who entered the military beginning in September 1986 so that test scores are measured consistently. We use the Armed Forces Qualifying Test (AFQT) which combines two of the math scores with two of the verbal scores. In addition to test scores, we have data on sex, age, education, service branch, race, ethnicity, marital status, and zip code of residence."

They thereby circumvent a problem pointed out by Carmit Segal in  “Working When No One is Watching: Motivation, Test Scores, and Economic Success,” Management Science, 58(8), 2012, pp. 1438-1457.

Another recent paper that correlates cognitive ability with income is by Syngjoo Choi, Shachar Kariv, Wieland Müller, and Dan Silverman: "Who Is (More) Rational?"

Their abstract reads: "Revealed preference theory offers a criterion for decision-making quality: if decisions are high quality then there exists a utility function that the choices maximize. We conduct a large-scale field experiment that enables us to test for consistency with utility maximization. We find that high-income and high-education subjects display greater levels of consistency than low-income and low-education subjects, men are more consistent than women, and young subjects are more consistent than older subjects. We also find that consistency with utility maximization is strongly related to wealth: a standard deviation increase in standard consistency scores is associated with 15-19 percent more wealth."

1 comment:

  1. Here's another recent paper in the same vein (with a data set I'm envious of):