Research Wire

A Live Baby or Your Money Back

Parenting is among the strongest and most basic of human instincts. Clinics that market in-vitro fertilization procedures to childless couples know this well. Several fertility clinics around the country these days aggressively tout such procedures, frequently offering couples two options. The first is an a la carte program in which couples pay $7,500 per attempt at having a so-called test tube baby. Alternatively, clinics offer a money-back guarantee. Couples pay $15,000 up front for three attempts — and if these fail, they get a full refund.

Which of these options represents the better choice? A study by David C. Schmittlein, Ira A. Lipman Professor of Marketing and chairperson of the Marketing Department at Wharton, and his associate Donald G. Morrison of the University of California at Los Angeles, provides an answer as it examines this controversial issue.

The study shows, expectedly, that from the patients’ perspective, the choice is usually a no-brainer: couples who have traditionally been considering in-vitro fertilization attempts would clearly be better off choosing the money-back option. From the clinics’ point of view, however, the decision to offer these money-back guarantees is harder to explain. Chances of an in-vitro fertilization attempt resulting in a live birth are roughly one in five. In addition, the cost to the clinic per attempt is fairly high. Why, then, would clinics offer patients a money-back guarantee, when this is almost certain to result in the clinics’ losing money?

Schmittlein explains that aggressive marketing of money-back guarantees in the media has brought about a shift in the behavior of infertile couples. In the past, childless couples tended to view in-vitro fertilization — a procedure usually not covered by health insurance — as their last resort. But now, for couples reassured by money-back guarantees, “in-vitro procedures are becoming the first choice,” Schmittlein says. As a result, younger and relatively less infertile couples have been choosing in-vitro fertilization. As they do this fairly early in their attempts to have a child, clinics receive a steady stream of business from couples likely to get a child on their first or second attempt.

Schmittlein points out that while neither clinics — which profit from these procedures — nor patients — who get a baby or a refund — are likely to complain about this situation, it has serious public policy ramifications. Patients should be made aware of the risks of in-vitro fertilization procedures, such as the possibility of multiple births. Some researchers also are concerned about a possible link between in-vitro fertilization and ovarian cancer. If couples were more fully informed, he adds, they might choose less invasive procedures than in-vitro fertilization, especially in their early attempts at parenthood.

David C. Schmittlein and Donald G. Morrison; A Live Baby or Your Money Back: The Marketing of In-vitro Fertilization Procedures

Why Shareholders Like to Invest at Home

At a time when stock markets around the world are getting hammered by the Asian flu and the ruble’s collapse, U.S. investors may need little persuasion to stay away from investing in foreign stocks. Interestingly, though, even when international stock markets are less troubled than they are now, investors still prefer to buy more stocks at home than abroad. In the process, they sacrifice potential gains they might have received by having an internationally diversified portfolio. Researchers call this phenomenon the “equity home bias.”

What is the effect of this trend on investors’ stock portfolios? Finance professor Karen Lewis, who has conducted substantial research on these issues, notes in a recent study that investors do not do a good job of hedging their investment risks across countries. Domestic and foreign stock markets do not move perfectly together, she says, which means that there is diversification potential for investing in foreign stocks. “Risk can be reduced, in the long term, by adding foreign stocks to your portfolio,” Lewis states. “For investors who hold no foreign stocks, increasing their holdings of foreign stocks somewhat can reduce their overall risk.”

Karen K. Lewis: Explaining Home Bias in Equities and Consumption

Filing for Bankruptcy? Big Deal!

Last year 1.35 million Americans — more than 1 per cent of households in the U.S. — declared bankruptcy. If that figure is not stunning enough, consider this: These numbers represented an increase of 73 per cent over 1994. Delinquency rates on credit cards are also rising fast. At a time when the U.S. economy is so strong, why should that be happening? The issue is an important one given that the U.S. Congress is currently debating major changes in the bankruptcy law.

Economists offer two major explanations. Some blame the so-called risk effect, in which less creditworthy borrowers receive more credit than they can handle. Others point to a so-called stigma effect. This suggests that the social stigma associated with declaring bankruptcy or defaulting on credit cards has declined. As a result, borrowers are more willing to stiff lenders than they were in the past.

Which of these two theories better explains the rising bankruptcy and default rates? So far that question has been difficult to answer. In a new study, however, finance professor Nicholas S. Souleles and his colleague, David B. Gross of the University of Chicago, draw upon detailed data about several hundred thousand credit-card users provided by several credit-card companies. The two researchers attempt to unravel the issue by studying the users’ behavior for eight quarters between 1995 and 1997.

Their conclusion: even if the behavior of users with similar risk profiles was tracked, the propensity to default went up between 1995 and 1997. That implies that the social stigma attached to filing bankruptcy and defaulting on credit card debt had declined. In other words, the stigma effect primarily drove the increase in bankruptcy filings and delinquencies. “We no longer put scarlet letters on people if they go bankrupt,” says Souleles. He adds that factors like increased advertising by bankruptcy lawyers might have also made borrowers more likely to declare bankruptcy.

This research has important implications for credit issuers, because even a small decline in stigma could spur large increases in bankruptcies and delinquencies. If that happens, creditors’ losses could significantly increase, which in turn could increase the cost of credit for borrowers in general.

Nicholas S. Souleles and David B. Gross: Explaining the Increase in Bankruptcy and Delinquency: Stigma Versus Risk Composition

Anatomy of a Low-cost Mutual Fund

In recent years index mutual funds, which mirror the movements of indices like the S&P 500, have become very popular. The cost of investing in such funds can be quite high, however, if they are pegged to indices of so-called small-cap stocks. Generally defined as stocks with a market capitalization of $750 million or less, small-cap stocks are often illiquid. As a result, trading stocks contained in small-cap index funds can be pricey: one-way costs of trading are typically as high as 2 per cent of the value of the transaction for these illiquid stocks.

One small-cap mutual fund, however, is an exception. The 9-10 Fund designed by Dimensional Fund Advisors, a money manager in Santa Monica, Calif., has trading costs that are not just low — they are sometimes negative. The fund gets its name from the fact that it is based on an index composed of small-cap stocks in the ninth and tenth (smallest) deciles of New York Stock Exchange market capitalization. Another factor that makes Dimensional Fund Advisors unusual is that its strategies are based on academic research. The firm’s board includes Nobel laureates like Myron Scholes of Stanford University and Merton Miller of the University of Chicago, as well as potential Nobel prizewinner Eugene Fama of Chicago.

So how does the 9-10 Fund achieve its contrarian success? In a fascinating case study, Donald B. Keim, professor of finance, explains that the fund’s performance is the result of its unusual design. “The DFA fund does not exactly mirror the performance of the small-cap universe,” he says. “It just tries to approximate it.” The approximation is due to an innovative trading strategy. In addition to trading patiently by waiting for favorable prices, fund managers also effectively act as market-makers for illiquid stocks. This allows them to buy stocks at discounted rather than at premium prices. Says Keim: “DFA simply aims for a high correlation between the 9-10 Fund and its performance benchmark. Thus, the 9-10 Fund does not precisely mirror the underlying index, but the tradeoff is that it saves investors money on transaction costs, improving the fund’s performance.”

Donald B. Keim; An Analysis of Mutual Fund Design: The Case of Investing in Small-Cap Stocks

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