|Year of selection||2009|
|Institution||Istituto Einaudi per l’Economia e la Finanza|
Type of support
1 900 000 €
Understanding Household Financial Decisions
What makes transactions possible? According to Professor Luigi Guiso, the answer is trust. Any financial exchange, whether it be an investment decision, the granting of a loan, the purchase of an insurance policy or the acceptance of a check to settle a transaction, is an exchange of money today for the promise of returning (more) money sometime in the future. Without trust, banks would not be willing to grant loans, and consumers would not buy insurance policies or invest in a corporation’s stock. Without trust, the economy would, in the end, fail to work. Professor Guiso believes that the importance of trust has been neglected in economics and especially in finance. By bringing trust back to the attention of economists, his research shows that trust beliefs matter considerably for people’s reliance on financial markets as well as for the development of financial markets.
Trust is even more important for households, whose choices are not always easy to understand, due to their extreme diversity. That’s why the characterization of preferences in terms of risk aversion in an expected utility framework may be too restrictive to capture the financial decisions of households. Professor Guiso is therefore studying new models of behavior in the face of risk and uncertainty that might take into account a richer characterization of preferences and additional dimensions of risk.
Today, individual investors and consumers have more and more intense interactions with the financial market. But are they good at making financial decisions? They may lack the ability to act according to what models of optimal behavior recommend, and this could cause important welfare losses. They are not playing alone in the market, and their lack of financial sophistication could be exploited by more skilled players. Household finance is a normative and positive study that can help fill the gap between the way they make decisions and the way they should make them.
“Today, household finance is a thriving, vibrant, self-standing field,” stated Professor Guiso. To give a sense of the relevance of household finance, the value of assets and liabilities held by households is much larger in most countries than the financial assets held by corporations. In the US (but the same is true in most countries) the mortgage market is as large as the market for corporate debt, and the market for consumer loans is as large as that of the private equity market. To the extent that market size is a measure of importance, household financial decisions deserve due attention.
The findings of this research program will be relevant for policy debates, such as those related to the role of financial literacy and the regulation of intermediaries offering financial products to households.
Luigi Guiso’s work on household financial decisions is both broad in scope and widely cited. Previously Director of the Finance Program at the Center for Economic Policy (CEPR), he has contributed to the promotion of the diffusion of research in household finance across Europe. Professor Guiso works at the Einaudi Institute for Economics and Finance (EIEF), a new independent institute created in 2008 by the Bank of Italy, which aims at producing world-class research in economics and finance in order to generate ideas that could be useful in policy debates. The aim is to foster an intellectually rich and highly dynamic environment that is strongly research-oriented and strictly meritocratic in its selection criteria. The AXA Research Fund decided to lend its support to this highly ambitious strategy. With the means to manage valuable research resources, EIEF has come one step further on the international scene of scientific excellence.
“There are a number of features that I consider extremely valuable in AXA’s funding scheme,” said Professor Guiso. “Selection criteria are based solely on academic merit, and AXA is extremely respectful of the research freedom of the beneficiary of the funding, while monitoring the uses of these funds. All these elements are key features for successful funding because they provide the right incentives to the researchers involved.”
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