Behavioural Characteristics and Financial Distress



1 Introduction

The financial crisis stemmed, in large part, from poor financial decisions and heightened
financial distress among households around the world. The years prior to the crisis saw
many people making bad financial choices from taking on levels of debt that they were not
able to manage, to spending beyond their means. The US sub-prime mortgage market, in
which people with poor credit history and income prospects took on debt which they could
not afford, is the best known example of this phenomenon but, closer to home, there are
numerous examples of European households facing financial woes because of poor financial
behaviour. In many cases these financial difficulties lead to serious problems for the people
involved. However, the enormous fiscal costs associated with a financial crisis are a reminder
that heightened financial distress and poor financial behaviour on the part of a relatively
small number of people can have serious negative externality effects on the rest of the
economy. In this context, understanding why people get into financial difficulties is key to
devising policies to minimise future episodes of financial distress. It is with this in mind
that the current study is undertaken.

Specifically, my goal in this paper is to identify the main factors that cause people to
experience financial distress. A key area that I focus on is whether people’s behavioural
traits, such as their capacities for self-control, planning, and patience, affect their ability
to manage their finances and stay out of financial trouble. I find that the variables that
proxy for behavioural traits are both statistically significant and economically important
for predicting both mild and extreme forms of financial distress, in a regression controlling
for demographic and socio-economic factors. Furthermore, behavioural traits emerge as
having a stronger impact on the incidence of financial distress than education or financial
literacy. For example, while having either a college education or being financially literate
reduces the likelihood of getting into financial trouble, being impulsive can undo all of this
benefit. These results suggest that policies to prevent people from getting into financial
difficulties must take behaviour into account.

I use data from Financial Capability Surveys carried out in the UK and Ireland in re-
cent years to undertake my analysis. These surveys were specially designed to shed light on
financial decision making and outcomes and they have not yet been utilised in the existing
international literature. They provide large nationally representative samples, collected
detailed data on demographics, income and wealth and also asked questions about people’s
daily financial lives, from how they manage their money to how they choose financial prod-



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