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Predatory Lending

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  • Rodrigue Mendez

    (EQUIPPE - ECONOMIE QUANTITATIVE, INTEGRATION, POLITIQUES PUBLIQUES ET ECONOMETRIE - Université Lille I - Sciences et technologies - Université Lille II - Droit et santé - Université Lille III - Sciences humaines et sociales - PRES Université Lille Nord de France)

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    Abstract

    This paper studies the equilibrium predatory practices that may arise when the borrowers have behavioral weaknesses. Rational lenders offer short term contracts that can be renewed at the cost of paying a penalty fee. We show how the optimal contracts depend on the degree of näıvet ́e of the time inconsistent customers. Penalty fees have a dual role : they increase market share by providing a useful commitment device to time-inconsistent but otherwise rational borrowers ; they are also a source of revenue from the semi-naïve borrowers who understand the need for commitment but fail to forecast their future time discount factor. We also show that perfect com- petition does not eliminate predatory practices, since the equilibrium contract entails a subsidized (below marginal cost) short-term loan that can only be profitable if a fraction of the borrowers end up paying the penalty fee.

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    Bibliographic Info

    Paper provided by HAL in its series Working Papers with number hal-00991948.

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    Date of creation: 2012
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    Handle: RePEc:hal:wpaper:hal-00991948

    Note: View the original document on HAL open archive server: http://hal.univ-lille3.fr/hal-00991948
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    Related research

    Keywords: hyperbolic discounting ; time inconsistency ; sophistication ; partial naï vet e ; exploitative contracts ; credit cards;

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    1. Ted O' Donoghue and Matthew Rabin., 2000. "Choice and Procrastination," Economics Working Papers E00-281, University of California at Berkeley.
    2. O'Donoghue, Ted & Rabin, Matthew, 1997. "Doing It Now or Later," Department of Economics, Working Paper Series qt7t44m5b0, Department of Economics, Institute for Business and Economic Research, UC Berkeley.
    3. Daniel Gottlieb, 2008. "Competition over Time-Inconsistent Consumers," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 10(4), pages 673-684, 08.
    4. Ted O'Donoghue & Matthew Rabin, 1997. "Incentives for Procrastinators," Discussion Papers 1181, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
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    7. Laibson, David I., 1997. "Golden Eggs and Hyperbolic Discounting," Scholarly Articles 4481499, Harvard University Department of Economics.
    8. Stefano Della Vigna & Ulrike Malmendier, 2004. "Contract Design and Self-control: Theory and Evidence," The Quarterly Journal of Economics, MIT Press, vol. 119(2), pages 353-402, May.
    9. Ted O'Donoghue & Matthew Rabin, 2005. "Optimal Sin Taxes," Levine's Bibliography 784828000000000346, UCLA Department of Economics.
    10. Kfir Eliaz & Ran Spiegler, 2006. "Contracting with Diversely Naive Agents," Review of Economic Studies, Oxford University Press, vol. 73(3), pages 689-714.
    11. Ted O'Donoghue & Matthew Rabin, 2003. "Studying Optimal Paternalism, Illustrated by a Model of Sin Taxes," American Economic Review, American Economic Association, vol. 93(2), pages 186-191, May.
    12. Sumit Agarwal & Paige Marta Skiba & Jeremy Tobacman, 2009. "Payday Loans and Credit Cards: New Liquidity and Credit Scoring Puzzles?," American Economic Review, American Economic Association, vol. 99(2), pages 412-17, May.
    13. Michael A. Stegman, 2007. "Payday Lending," Journal of Economic Perspectives, American Economic Association, vol. 21(1), pages 169-190, Winter.
    14. Ausubel, Lawrence M, 1991. "The Failure of Competition in the Credit Card Market," American Economic Review, American Economic Association, vol. 81(1), pages 50-81, March.
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