IDEAS home Printed from
MyIDEAS: Log in (now much improved!) to save this paper

Payday Loans, Consumption Shocks, and Discounting

Listed author(s):
  • Jeremy Tobacman
  • Paige Skiba


    (Department of Economics Harvard University)

Payday loans are high-interest rate, short-term loans which mature on borrowers' paydays, have terms equal to the duration of one pay cycle, and are collateralized with post-dated personal checks. Roughly nine million American households borrowed on payday loans in 2002, typically paying annualized interest rates above seven thousand percent. With a unique new dataset of nearly two million payday loan applications, we examine two hypotheses for why consumers use these extremely expensive financial instruments. First, consumers may experience shocks to consumption needs like expenses for health care or car repairs. These shocks could raise the marginal utility of consumption enough to account for borrowing at very high interest rates. Second, consumers may have strong preferences for immediate consumption over consumption in the future. To test these hypotheses formally we build a dynamic structural model of consumption and borrowing behavior. In our benchmark specification sophisticated agents have access to liquid assets and face income uncertainty as is standard in this literature. Consumers also face borrowing constraints except for the opportunity to borrow on institutionally realistic payday loans. As the key innovation in our benchmark model, we incorporate stochastic consumption shocks. We use a numerical backward induction algorithm to solve for the stationary Markov Perfect Equilibrium of the model, and with these MPE strategies we simulate the behavior of a population of consumers. Moments calculated from the simulated and empirical populations permit us to estimate the free parameters of the structural model using a two-stage Method of Simulated Moments (MSM) procedure (Gourinchas and Parker 2002, Laibson, Repetto, and Tobacman 2004). We find that consumption shocks alone cannot account qualitatively or quantitatively for observed payday borrowing behavior, so we examine two extensions of the benchmark model. When we permit overoptimism about future consumption shocks and higher discount rates in the short run than in the long run, the model's fit improves and we statistically reject the benchmark model's assumptions. Since the median income of payday borrowers in our sample is about $20,000 per year, our results contribute important insights about the circumstances and choices of low-income decision-makers

To our knowledge, this item is not available for download. To find whether it is available, there are three options:
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2005 with number 189.

in new window

Date of creation: 11 Nov 2005
Handle: RePEc:sce:scecf5:189
Contact details of provider: Web page:

More information through EDIRC

No references listed on IDEAS
You can help add them by filling out this form.

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:sce:scecf5:189. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum)

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.