Errors in financial expectations, over-indebtedness and unhealthy behaviours: evidence from Russia and South Africa

This thesis presents three empirical studies on errors in financial expectations. All studies employ micro-level survey data. In the first study, using the Russian Longitudinal Monitoring Survey over the period 2002-2016, I examine the determinants of individuals’ errors in financial expectations, focusing on the role of past income changes and job insecurity. Consistent with the over-extrapolation of their past experience, I observe that individuals become over-optimistic after their financial situation improves, and over-pessimistic after their financial situation worsens. Furthermore, I find that individuals over-extrapolate income gains more than income losses. Turning to the role of job insecurity, I observe that individuals who are confident at finding a new job if laid-off are more likely to show over-optimism. In addition, I document that the more confident respondents are at finding a new job, the larger the forecast error they make. These results are robust to using a wide range of estimators including fixed-effects estimators, fixed-effects instrumental variable estimators and correlated random effects Probit estimators. They are also robust to using different proxies for errors in financial expectations. In the second study, using the Russia Longitudinal Monitoring Survey, which includes over 120,000 observations spanning 16 years, I investigate the relationship between errors in financial expectations and unhealthy behaviours. I employ a wide range of estimation methods including fixed effects linear probability models, conditional fixed effects Logit models, fixed effects quantile regression models, fixed effects Negative Binomial models, and the generalized method of moments (GMM). I find that extreme optimism (i.e. overestimating future household finances) is associated with higher probabilities of smoking and drinking, and higher cigarette and alcohol consumption. Consistent with the Tension Reduction Theory, I find that psychological ill-being is the channel through which extreme optimism is associated with unhealthy behaviours. Finally,I find that errors in financial expectations tend to affect drinking for males, and smoking for females, which indicates Russian males and females have different coping strategies in response to stress. The results are robust to using both static and dynamic models. In the third study, using the 2010 and 2017 waves of the South Africa National Income Dynamics Survey, I examine the relationship between errors in financial expectations and individuals’ borrowing decisions. I find robust evidence that individuals with optimistic forecast errors show a higher probability of taking financial, personal and short-term debt. They also show higher levels of debt and a higher probability of being over-indebted. Furthermore, I document positive moderating effects of low education and debt illiteracy in the relationship between optimistic forecast errors and borrowing. This suggests that optimists may take more debt due to a lack of understanding of debt contracts and mis-judgement of their debt positions. My results are robust to using a wide range of estimation methods including fixed-effects linear models and correlated random effects Probit and Tobit models. They are also robust to using different measures of forecast errors