The larger the lottery reward a lucky gambler collects, the more likely his or her neighbors are to file for bankruptcy, according to a new working paper from the Philadelphia Federal Reserve that sought to find analytical backing for the “keeping up with the Joneses” theory.

The research found that social pressure to compete with one’s neighbors on exciting new purchases is so great that it leads to a significant increase in both the amount of credit and mortgages people are willing to incur, the paper finds.

“We find that the magnitude of the neighbor’s lottery win is related to the dollar value of more visible, but not less visible consumption assets,” wrote Sumit Agarwal of Georgetown University and Vyacheslav Mikhed of the Federal Reserve Bank of Philadelphia.

“The magnitude of lottery wins increases the value of risky financial assets (securities) on the balance sheets of nonlottery-winning neighbors at the time of bankruptcy filing,” they added. “On the other hand, the magnitude of the lottery win has no effect on cash and (weakly) decreases less risky assets.”

The researchers studied the effects a one-time income boost for one person on the financial stability of that person’s neighbors. Limiting the sample to a collection of small neighborhoods in Canada, the researchers wrote, helped guarantee that neighbors witnessed any obvious changes in consumption by lottery winners. The one lucky winner, they reason, should be clear thanks to flashy purchases like a new car or a larger house.

Among its main findings, the study observed that a lottery win equal to the median annual income for the communities studied increases the rate of bankruptcies among neighbors by 0.03 in the three years after the win, a 6.59 percent increase relative to the average bankruptcy rate.

In turn, that type of “conspicuous consumption” pressures neighbors into spending more themselves. But while social pressures can lead to compelling academic theories, upticks riskier borrowing appeared to have more insidious economic implications.

While the size of the lottery win didn’t affect neighbors’ credit in the years prior to a lottery win, the researchers found increases in both the number of accounts as well as the dollar balances after lottery wins, implying a net increase in borrowing in neighborhoods following an isolated income shock.

In terms of magnitude, Agarwal and Mikhed found that a 10 percent increase in the lottery amount would buoy all credit accounts by 0.003 and total balances by $134 in the second year after the win.

They also observed a shift in the housing market; according to their calculations, a 10 percent increase in the lottery prize would result in 0.0007 additional mortgages and an additional $165 in mortgage balances in the second year after the win.

“Taken together, these findings are suggestive of the increased borrowing of neighbors because of relative income comparisons, leading to financial distress,” Agarwal and Mikhed wrote.

“While the results in this paper are based on microgeographies, [by] examining the very close neighbors of lottery winners, future research could possibly examine whether these results are important for the entire economy,” they said.

Source: cnbc economy
There's now analytical proof behind 'keeping up with the Joneses'