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Why You Might Go Bankrupt If Your Next-Door Neighbor Wins the Lottery

By February 18, 2016No Comments
lottery balls

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Winning the lottery can be hazardous to your neighbors’ financial health.

Research released this month by the Federal Reserve Bank of Philadelphia found a significant jump in bankruptcies among households living near someone who won a big lottery jackpot. The economists theorized that people may have seen the good fortune next door and felt pressure to accumulate more assets of their own, especially flashy purchases like cars, that they simply could not afford.

“Income inequality induces poorer neighbors to consume more visible (rather than invisible) commodities to signal their abilities to ‘keep up with the Joneses’ to their richer neighbors,” economists Sumit Agarwal, Vyacheslav Mikhed and Barry Scholnick wrote. “This tendency can lead to additional and unsustainable borrowing among the relatively poor to finance this additional conspicuous consumption, which can eventually result in financial distress and bankruptcy.”

Mr. Agarwal is a professor at the National University of Singapore, Mr. Mikhed works at the Philadelphia Fed’s Payment Cards Center and Mr. Scholnick is a professor at the University of Alberta. Their research was circulated in a Philadelphia Fed working paperand relies on administrative data from an unnamed Canadian province. They analyzed lottery prizes and bankruptcy filings over 10 years, sorted down to six-digit postal codes that on average contained only 13 households, revealing financial ripple effects on a lottery winner’s closest neighbors. They limited their analysis to neighborhoods with a single lottery win and excluded cases when lottery winners themselves filed for bankruptcy. They also omitted fixed-payout lottery prizes and very large jackpots.

The headline finding: For every $1,000 increase in the lottery prize, there was a 2.4% increase in bankruptcy filings by the winner’s neighbors over the next few years. “These results are more pronounced for low-income neighborhoods and high income-inequality areas,” they wrote.

Why would someone winning the jackpot cause someone living down the street to go bankrupt a year or two later? The economists argued that people who feel they are poorer than their peers may spend more in a conspicuous fashion, financing their purchases with debt. But that debt will need to be repaid, potentially leading to financial difficulties and even bankruptcy.

Messrs. Agarwal, Mikhed and Scholnick analyzed the Canadian bankruptcy data and found “evidence that those who filed for bankruptcy after a larger lottery win of a close neighbor have significantly larger holdings of visible assets (e.g., cars, motorcycles, houses) relative to the holdings of these same visible assets by those who filed for bankruptcy after smaller lottery wins of a close neighbor,” they wrote. There was no similar difference for “invisible assets” like cash or pensions, they said.

In other words, when someone wins a big lottery prize, neighbors appear more likely to buy cars and remodel their houses to show that they can keep up—and go broke in the process.

By demonstrating what the economists described as “causal evidence on the link between income inequality and financial distress,” their paper adds to the recent flowering of economic research on the causes and effects—both individual and economy-wide—of wealth and income inequality, a hot topic well beyond academic circles. It also, they noted, adds to the growing use of data on lottery winners to examine the economic and social effects of sudden income windfalls.



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