Events at CERGE-EI

Karna Basu, Ph.D.

Hunter College, City University of New York, USA

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Author: Karna Basu

Abstract: Exponential growth bias--the tendency to under-estimate compound interest--has been documented in several papers. Using survey data from India, I find that the bias exists only for high interest rates and long time horizons. When interest rates are low or time horizons short, the bias is reversed and individuals over-predict compound interest yields. I argue that this two-directional bias reflects an excessively linearized correction of one's initial under-prediction. I build a model to show how this results in sub-optimal saving and borrowing choices, time-inconsistent behavior, aversions to long-term savings and short-term debt, and simultaneous saving and borrowing.
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Full Text:  “A Biased Correction of Exponential Growth Bias: Evidence and Theoretical Implications”