Date of Award

5-2026

Degree Type

Report

Degree Name

Master of Science (MS)

Department

Economics and Finance

Committee Chair(s)

T. Scott Findley

Committee

T. Scott Findley

Committee

James Feigenbaum

Committee

Ben Blau

Abstract

This paper studies the effects of overconfidence in a lifetime consumption and savings model that allows for debt accumulation. Overconfidence, a well-documented behavioral bias, leads individuals to hold distorted perceptions of the different interest rates that they face on their savings and on their borrowings. While existing life-cycle models with overconfidence abstract from debt, I introduce a spread between the interest rates on savings and on borrowings, where the overconfident individual forms distorted perceptions of this spread. To model the actual and the perceived spreads, a continuously differentiable logistic function is utilized, and these spreads are incorporated into a standard optimal control problem of life-cycle decision-making. I show via simulation how overconfidence affects key decisions like consumption, saving, and borrowing. These decisions, in addition to the effects on welfare, are compared to those of an otherwise-identical individual who is rational. Findings of the model suggest that overconfidence impacts lifetime welfare negatively. Specifically, overconfidence regarding the interest rate paid on borrowings reduces welfare disproportionately to overconfidence about the interest rate earned on savings.

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