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Observing Unobservables: Identifying Information Asymmetries with a Consumer Credit Field Experiment

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  • Karlan, Dean S.
  • Zinman, Jonathan

Abstract

Information asymmetries are important in theory but difficult to identify in practice. We estimate the empirical importance of adverse selection and moral hazard in a consumer credit market using a new field experiment methodology. We randomized 58,000 direct mail offers issued by a major South African lender along three dimensions: 1) the initial "offer interest rate" appearing on direct mail solicitations; 2) a "contract interest rate" equal to or less than the offer interest rate and revealed to the over 4,000 borrowers who agreed to the initial offer rate; and 3) a dynamic repayment incentive that extends preferential pricing on future loans to borrowers who remain in good standing. These three randomizations, combined with complete knowledge of the Lender's information set, permit identification of specific types of private information problems. Specifically, our setup distinguishes adverse selection from moral hazard effects on repayment, and thereby generates unique evidence on the existence and magnitudes of specific credit market failures. We find evidence of both adverse selection (among women) and moral hazard (predominantly among men), and the findings suggest that about 20% of default is due to asymmetric information problems. This helps explain the prevalence of credit constraints even in a market that specializes in financing high-risk borrowers at very high rates.

Suggested Citation

  • Karlan, Dean S. & Zinman, Jonathan, 2005. "Observing Unobservables: Identifying Information Asymmetries with a Consumer Credit Field Experiment," Center Discussion Papers 28482, Yale University, Economic Growth Center.
  • Handle: RePEc:ags:yaleeg:28482
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Dean S. Karlan, 2005. "Using Experimental Economics to Measure Social Capital and Predict Financial Decisions," American Economic Review, American Economic Association, vol. 95(5), pages 1688-1699, December.
    2. Duflo, Esther & Glennerster, Rachel & Kremer, Michael, 2008. "Using Randomization in Development Economics Research: A Toolkit," Handbook of Development Economics, Elsevier.
    3. Marianne Bertrand & Dean Karlin & Sendhil Mullainathan & Eldar Shafir & Jonathan Zinman, 2005. "What's Psychology Worth? A Field Experiment in the Consumer Credit Market," NBER Working Papers 11892, National Bureau of Economic Research, Inc.
    4. Ashraf Nava & Karlan Dean & Yin Wesley, 2006. "Deposit Collectors," The B.E. Journal of Economic Analysis & Policy, De Gruyter, vol. 5(2), pages 1-24, March.
    5. Robert Cull & Asli Demirguç-Kunt & Jonathan Morduch, 2007. "Financial performance and outreach: a global analysis of leading microbanks," Economic Journal, Royal Economic Society, vol. 117(517), pages 107-133, February.
    6. Xavier Giné & Pamela Jakiela & Dean Karlan & Jonathan Morduch, 2010. "Microfinance Games," American Economic Journal: Applied Economics, American Economic Association, vol. 2(3), pages 60-95, July.
    7. Simpson, Wayne & Buckland, Jerry, 2009. "Examining evidence of financial and credit exclusion in Canada from 1999 to 2005," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 38(6), pages 966-976, December.
    8. Amy Finkelstein & James Poterba, 2014. "Testing for Asymmetric Information Using “Unused Observables” in Insurance Markets: Evidence from the U.K. Annuity Market," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 81(4), pages 709-734, December.
    9. Ashraf, Nava & Karlan, Dean S. & Yin, Wesley, 2005. "Deposit Collectors," Center Discussion Papers 28502, Yale University, Economic Growth Center.
    10. Dean Karlan & Jonathan Zinman, 2005. "Elasticities of Demand for Consumer Credit," Working Papers 926, Economic Growth Center, Yale University.
    11. Stijn Claessens & Erik Feijen, 2006. "Financial Sector Development and the Millennium Development Goals," World Bank Publications, The World Bank, number 7145.

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