How Our Collective Struggle With Self-Control Shapes Stock Prices

Overspending rises in times of stress and that affects investment decisions

Resolutions to start saving usually begin with “tomorrow.” And when tomorrow arrives, we end up ordering takeout, booking trips or clicking “add to cart” while promising ourselves we’ll be more disciplined next week.

Economists call this tug-of-war between intention and action “present bias,” our tendency to value today’s rewards more than tomorrow’s. Research from psychology and neuroscience suggests that stress can impair the brain’s ability to maintain self-control, causing this bias to fluctuate.

A working paper builds on this research linking stress to changing levels of present bias. UCLA Anderson’s Lars A. Lochstoer and BI Norwegian Business School’s Stig R.H. Lundeby and Zhaneta K. Tancheva argue that when the public’s collective self-control weakens, perhaps due to an economic stress, it can leave a detectable fingerprint on stock and bond prices. Their paper analyzes the asset pricing implications of the populace’s collective present bias as it varies over time.

The Stress Gap

To see if this bias affects real spending, the researchers looked to the Federal Reserve Bank of New York’s Survey of Consumer Expectations data from December 2014 to December 2022. In this survey, thousands of Americans are asked to predict their household spending growth. A year later, participants were asked how much it actually had grown.

On average, people spent roughly 2 percentage points more than they expected. But the pattern wasn’t uniform. Low-income or less-educated households tended to underestimate future spending by around 6 percentage points annually, and even more in stressful times. Higher-income households were nearly accurate with their forecasts. 

The researchers matched this information with state-level unemployment data to see how the job data predicted the error in spending expectations. The results suggest that when joblessness rose, forecast errors by vulnerable groups widened. Stressful periods appeared to weaken their self-control, expanding the gap between intention and action.

Lochstoer, Lundeby and Tancheva interpret the behavior seen in the survey as “partial naiveté.” People recognize that others overspend, but underestimate their own future lapses, constantly expecting a more disciplined version of themselves to arrive shortly.

The team used the New York Fed survey participants’ forecast errors to calibrate a simulated economy in which new investors constantly replace older ones. They translated the survey errors into a parameter representing time-varying present bias in which the larger the error in stressful times, the more present bias intensified. 

The simulation included two types of investors in the economy. These were time-consistent planners who stuck to long-term plans and present-biased investors modeled on the survey data. The latter overspent, lost self-control in bad times and remained overly optimistic about their future discipline.

Using a sample equal to 20,000 years of simulated monthly market activity, the model shows present-biased investors ended up holding, on average, only about 15% of the total wealth, despite making up half of the population. This was due to their overconsumption. 

Despite their small financial footprint, their psychology still impacted market prices.

The Cost of ‘Future Me’

The key mechanism of their impact is subtle. Present-biased investors believe they will eventually become patient and save more. In reality, that shift never happens, but they plan as if it might. This creates a perceived vulnerability. They fear they will become disciplined just as the market crashes. 

In that scenario, widespread impatience drives down asset prices, crushing the value of their existing stock holdings. If they become disciplined at that moment, they must cut consumption on a shrunken nest egg — precisely when it hurts most.

To bear this subjective risk — the possibility of needing to tighten belts in bad times — they demand extra compensation to hold stocks. The risk exists only in their heads, but it creates real effects on asset prices. The extra compensation comes in the form of lower prices.

The authors suggest that their findings provide a missing piece of the asset-pricing puzzle, noting that the model “offers an alternative mechanism for the large swings in discount rates observed in financial markets.”

When the researchers calibrated their model to the survey data, the model’s simulated results mirrored reality:

• The equity risk premium averaged around 3.7% per year, compared with roughly 2.2% in an otherwise similar economy where everyone is fully rational. 
• Stock return volatility was higher — around 12% versus roughly 10% in the rational economy — explaining the excess price swings we observe in real markets. 
• Long-term government bonds yielded more than short-term ones, producing an upward-sloping yield curve similar to real-world Treasuries. 

The researchers’ findings suggest that when present bias is held constant over time, the extra risk premium and volatility in the market largely vanish. It’s the fluctuation of investors’ degree of impatience with stress that generates the “discount-rate risk”— the danger that stock prices fall simply because the market has collectively become more impatient and investors demand extra compensation to bear this exposure.

While simplified, their model offers a coherent connection between our internal struggles and external prices. For individuals, the takeaway is that stress makes our plans less reliable. For markets, the work suggests that some of the ups and downs in required returns may trace back not just to news about earnings or the economy, but to something more familiar — the difficulty of keeping promises to our future selves.