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Subprime Consumer Credit Demand: Evidence from a Lender's Pricing Experiment

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  • Sule Alan

    ()
    (Faculty of Economics and CFAP University of Cambridge, UK and Koc University, Turkey)

  • Ruxandra Dumitrescu

    (Faculty of Economics and CFAP University of Cambridge, UK)

  • Gyongyi Loranth

    (Faculty of Business, Economics and Statistics University of Vienna and CEPR)

Abstract

We test the interest rate sensitivity of subprime credit card borrowers using a unique panel data set from a UK credit card company. We were given details of a randomized interest rate experiment conducted by the lender between October 2006 and January 2007. Access to such information is rare. We first calibrate an intertemporal consumption model to show that the experimental design has sufficient statistical power to detect economically plausible responses among borrowers. We then 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 isolating exogenous variation in interest rates when estimating credit demand elasticities. We show that estimating a standard credit demand equation with the nonexperimental variation in the data leads to severely biased estimates. This is true even when conditioning on a rich set of controls and individual fixed effects.

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File URL: http://eaf.ku.edu.tr/sites/eaf.ku.edu.tr/files/erf_wp_1105.pdf
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Bibliographic Info

Paper provided by Koc University-TUSIAD Economic Research Forum in its series Koç University-TUSIAD Economic Research Forum Working Papers with number 1105.

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Length: 39 pages
Date of creation: Mar 2011
Date of revision:
Handle: RePEc:koc:wpaper:1105

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Keywords: subprime credit; randomized trials; liquidity constraints;

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References

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  1. Alessie, Rob & Hochguertel, Stefan & Weber, Guglielmo, 2001. "Consumer Credit: Evidence from Italian Micro Data," CEPR Discussion Papers 3071, C.E.P.R. Discussion Papers.
  2. William Adams & Liran Einav & Jonathan Levin, 2009. "Liquidity Constraints and Imperfect Information in Subprime Lending," American Economic Review, American Economic Association, vol. 99(1), pages 49-84, March.
  3. Sule Alan, 2005. "Entry Costs and Stock Market Participation Over the Life Cycle," Social and Economic Dimensions of an Aging Population Research Papers 126, McMaster University.
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Cited by:
  1. Cho, Sung-Jin & Rust, John, 2012. "Does Zero Interest Work as An Important Marketing Tool?," Research Center for Price Dynamics Working Paper Series 5, Research Center for Price Dynamics, Institute of Economic Research, Hitotsubashi University.
  2. Cláudio Ribeiro de Lucinda & Rodrigo Luiz Vieira, 2011. "An Experimental Analysis of the Brazilian Personal Credit Market," Working Papers 10-2011, Universidade de São Paulo, Faculdade de Economia, Administração e Contabilidade de Ribeirão Preto.
  3. Helen Higgs & Andrew C. Worthington, 2011. "Price and income elasticity of Australian retail finance: An autoregressive distributed lag (ARDL) approach," Discussion Papers in Finance finance:201117, Griffith University, Department of Accounting, Finance and Economics.

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