The Leverage Self-Delusion: Perceived Wealth and Cognitive Sophistication

Author: Alberto Cardaci (Goethe University), Tiziana Assenza (Toulouse School of Economics) and Domenico Delli Gatti (Università Cattolica, Milan)

Title: The Leverage Self-Delusion: Perceived Wealth and Cognitive Sophistication

Abstract: Theoretical and empirical studies show that individuals frequently misperceive the value of their wealth. We conduct a laboratory experiment to study whether individual characteristics explain this misperception. We find that most subjects perceive a given net worth as greater than its true value. We identify a cognitive underpinning: these subjects have low cognitive sophistication and form wealth perceptions by tunneling attention towards the leverage ratio, an “improper” measure of the balance sheet composition in our context. Finally, greater wealth misperception also correlates with lower patience, lower debt aversion and greater likelihood to increase spending out of positive income shocks.