Eliciting Individuals’ Financial Decision-Making Approaches with Verbal Protocols

Abstract

How do individuals approach financial decisions? Do they apply sophisticated formulas, 'back of the envelope'-math, do they guess, or something completely different? We show that the verbal protocol method – i.e., having individuals explain their approaches – generates new insights to answer these questions. Our findings on approaches discovered are reliable within sample and have predictive power out of sample. Among other things, we find that when assessing the value of an annuity, 40% of individuals use some math, and some even use formulas similar to actuaries; the other 60% seem to guess. Valuation approaches used predict valuation outcomes and valuation precision, explain puzzling findings reported in earlier literature, and predict a behavioral reaction to an anchoring intervention designed to match one of the approaches discovered. The verbal protocol method opens new pathways to understand financial decision-making as well as to design effective policy interventions.