NCPA - National Center for Policy Analysis


January 21, 2009

Many economists are unsettled by the idea of a generation of "Depression babies" -- people who grew up during the Depression and, scarred by the poor stock market returns of their formative years, were unusually risk-averse in their investments throughout their lives.  Standard models assume that individuals use all available information about the present and past to make financial decisions; yet, new research from Ulrike Malmendier (University of California at Berkeley) and Stefan Nagel (Stanford University) seems to confirm that people born at different times make very different financial choices, even in similar economic environments.

They examined data about American households' finances between 1964 and 2004, and because they knew when the people in the sample were born, they could calculate the average stock market returns and inflation that individuals had experienced over the course of their lives.  As a result, their work confirmed the Depression babies' idea:

  • Under identical market conditions and controlling for age, people who had experienced lower stock market returns over the course of their lives put a smaller fraction of their money into stocks than people who had lived, on average, in times when stocks had done better.
  • Part of the explanation appears to be that beliefs are disproportionately affected by lived experience.
  • They also found that people who have lived through periods of high inflation systematically expect future inflation to be higher than those who have not experienced high inflation for themselves.

What's more, the effect of the distant past dissipates much more slowly than expected, with the impact of events early in life persisting into the future.  They were also surprised to find that people's eventual appetite for risk is affected by the economic environment during their childhood, well before financial matters could possibly have been of interest.

Source: Editorial, "The bonds of time," The Economist, January 8, 2009; Ulrike Malmendier and Stefan Nagel, "Depression Babies: How Our Economic Experiences Affect Investment Behavior," December 2008.

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