Exponential Growth Bias and Household Finance

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Abstract
Exponential growth bias is the pervasive tendency to linearize exponential functions when assessing them intuitively. We show that exponential bias can explain two systematic biases in household finance: the tendency to underestimate an interest rate given other loan terms, and the tendency to underestimate a future value given other investment terms. Bias matters empirically: More-biased households borrow more, save less, favor shorter maturities for debt and assets, and use and benefit more from financial advice, conditional on a rich set of household characteristics. There is little evidence that our measure of exponential growth bias merely proxies for broader financial sophistication.