New Paper: ‘Self-Control, Financial Literacy and the Co-Holding Puzzle’

J. Gathergood and I have released a new paper titled ‘Self-Control, Financial Literacy and the Co-Holding Puzzle’. It is concerned with the empirical phenomenon that a substantial proportion of the population hold liquid savings and unsecured credit simultaneously – and not small sums, but in the region of £6,000 or more. It is available on SSRN and the abstract tells you more:

We use UK household survey data incorporating measures of financial literacy and behavioural characteristics to analyse the puzzling co-existence of high cost revolving consumer credit alongside low yield liquid savings in household balance sheets, which we term the ‘co-holding puzzle’. Approximately 20% of households in our sample co-hold, on average, £6,500 of revolving consumer credit alongside £8,000 of liquid savings. Co-holders are typically more financially literate, with above average income and education. However, we show co-holding is also associated with impulsive spending behaviour on the part of the household. Our results lend empirical support to theoretical models in which sophisticated households co-hold as a means of managing a self-control problem.

So why do these households not simply payoff their credit and save a substantial amount of money? The intuitive answer is that households want to keep cash as a measure of last resort, for example for (unexpected) expenditure that cannot be paid off using credit. This paper by Telyukova mentions medical and housing expenses that cannot be paid off using credit card. But is it reasonable to assume that households expect to pay off these large sums in the future? Also, Telyokova’s argument focuses on credit card co-holding, but in the UK consumers hold complex credit portfolios, including payday loans, car loans, overdrafts etc. These forms of credit can be used to pay off almost all expenditure, and are readily available.

We focus on another explanation: we find that households that are more likely to co-hold are typically more sophisticated, i.e. have larger incomes and higher financial literacy, but score high on a self-reported measure on impulsiveness. The intuition is that they anticipate impulsive spending, but – because they are sophisticated – deliberately hold outstanding consumer credit balances so as to limit the spending possibilities.