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Subprime consumer credit demand: evidence from a lender's pricing experiment

  • Alan, Sule
  • Dumitrescu, Ruxandra
  • Loranth, Gyongyi

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. JEL Classification: D11, D12, D14

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Paper provided by European Central Bank in its series Working Paper Series with number 1304.

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Date of creation: Feb 2011
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Handle: RePEc:ecb:ecbwps:20111304
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  1. 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.
  2. John List & Mathis Wagner & Sally Sadoff, 2010. "So you want to run an experiment, now what? Some simple rules of thumb for optimal experimental design," Artefactual Field Experiments 00094, The Field Experiments Website.
  3. Attanasio, Orazio P, et al, 1999. "Humps and Bumps in Lifetime Consumption," Journal of Business & Economic Statistics, American Statistical Association, vol. 17(1), pages 22-35, January.
  4. 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.
  5. Dean S. Karlan & Jonathan Zinman, 2008. "Credit Elasticities in Less-Developed Economies: Implications for Microfinance," American Economic Review, American Economic Association, vol. 98(3), pages 1040-68, June.
  6. 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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