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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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    9. Michael A. Stegman, 2007. "Payday Lending," Journal of Economic Perspectives, American Economic Association, vol. 21(1), pages 169-190, Winter.
    10. Ted O' Donoghue and Matthew Rabin., 2000. "Choice and Procrastination," Economics Working Papers E00-281, University of California at Berkeley.
    11. Laibson, David, 1997. "Golden Eggs and Hyperbolic Discounting," The Quarterly Journal of Economics, MIT Press, vol. 112(2), pages 443-77, May.
    12. Ted O'Donoghue & Matthew Rabin, 2005. "Optimal Sin Taxes," Levine's Bibliography 784828000000000346, UCLA Department of Economics.
    13. Malmendier, Ulrike M. & Della Vigna, Stefano, 2003. "Contract Design and Self Control: Theory and Evidence," Research Papers 1801, Stanford University, Graduate School of Business.
    14. Stefano DellaVigna & Ulrike Malmendier, 2006. "Paying Not to Go to the Gym," American Economic Review, American Economic Association, vol. 96(3), pages 694-719, June.
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