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Subprime Consumer Credit Demand: Evidence from a Lender?sPricing Experiment

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  • Sule Alan

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  • Ruxandra Dumitrescu
  • Gyongyi Loranth
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    Abstract

    We test the interest rate sensitivity of subprime credit card borrowers using a unique panel data set from a UK credit card company. What is novel about our contribution is that we were given details of a randomized interest rate experiment conducted by the lender between October 2006 and January 2007. We find that individuals who tend to utilize their credit limits fully do not reduce their demand for credit when subject to increases in interest rates as high as 3 percentage points. This finding is naturally interpreted as evidence of binding liquidity constraints. We also demonstrate the importance of truly exogenous variation in interest rates when estimating credit demand elasticities. We show that estimating a standard credit demand equation with nonexperimental variation leads to seriously biased estimates even when conditioning on a rich set of controls and individual fixed effects. In particular, this procedure results in a large and statistically significant 3-month elasticity of credit card debt with respect to interest rates even though the experimental estimate of the same elasticity is neither economically nor statistically different from zero.

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    File URL: http://www.bcl.lu/fr/publications/cahiers_etudes/60/BCLWP060.pdf
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    Bibliographic Info

    Paper provided by Central Bank of Luxembourg in its series BCL working papers with number 60.

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    Length: 40 pages
    Date of creation: Feb 2011
    Date of revision:
    Handle: RePEc:bcl:bclwop:bclwp060

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    Web page: http://www.bcl.lu/

    Related research

    Keywords: subprime credit; randomized trials; liquidity constraints;

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    1. John List & Sally Sadoff & Mathis Wagner, 2011. "So you want to run an experiment, now what? Some simple rules of thumb for optimal experimental design," Experimental Economics, Springer, vol. 14(4), pages 439-457, November.
    2. Karlan, Dean S. & Zinman, Jonathan, 2007. "Credit Elasticities in Less-Developed Economies: Implications for Microfinance," CEPR Discussion Papers 6071, C.E.P.R. Discussion Papers.
    3. Orazio P. Attanasio & James Banks & Costas Meghir & Guglielmo Weber, 1995. "Humps and Bumps in Lifetime Consumption," NBER Working Papers 5350, National Bureau of Economic Research, Inc.
    4. Sule Alan, 2005. "Entry Costs and Stock Market Participation Over the Life Cycle," Working Papers 2005_1, York University, Department of Economics.
    5. Rob Alessie & Stefan Hochguertel & Guglielmo Weber, 2005. "Consumer Credit: Evidence From Italian Micro Data," Journal of the European Economic Association, MIT Press, vol. 3(1), pages 144-178, 03.
    6. William Adams & Liran Einav & Jonathan Levin, 2007. "Liquidity Constraints and Imperfect Information in Subprime Lending," NBER Working Papers 13067, National Bureau of Economic Research, Inc.
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