A fascinating new study from NYU Stern examines how tourists convert foreign currencies to make spending decisions. Specifically, when tourists pay with foreign currencies, they will overspend or underspend, depending on the exchange rate.

The study was done by Priya Raghubir, Research Professor of Marketing, and Vicki Morwitz, Harvey Golub Professor of Business Leadership, along with PhD student Shelle Santana.

Some findings:
— Tourists suffer from the “money-illusion” effect. Example: when an American travels to Japan where the exchange is $1 = 78 Yen, they tend to underspend. A price of 800 yen can be off-putting when in reality, it’s just a little more than $10. The reverse happens when the foreign currency is a fraction of the home currency.
— Consumers succumb to the “money-illusion” effect because they use the face value of the product price as a starting anchor and work backwards from it.
— When exchange rates make conversation difficult (e.g., 1 US dollar = 52.00 Indian Rupees), people naturally tend to round (e.g., $1 = Rs 50). Using this sample conversion rate, an American tourist in India is likely to overspend as a result of rounding down.
— Tourist spending in continental Euro countries was higher than in non-Euro countries after the changeover to the Euro. The researchers attribute this to the change in face values of prices following the changeover and refer to this as the “Europoly Effect.”

The researcher advise travelers to be aware of their natural biases and instead use calculators and mobile apps to do accurate conversions.

The full study/research paper is here in Journal of Retailing, though prices at $31.50, which our local currency to local currency “money illusions”, seems high.