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

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Author Info
Dean S. Karlan () (Economic Growth Center, Yale University and Princeton University)
Jonathan Zinman () (Federal Reserve Bank of New York)

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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.

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Paper provided by Economic Growth Center, Yale University in its series Working Papers with number 911.

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Length: 57 pages
Date of creation: May 2005
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Handle: RePEc:egc:wpaper:911

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Related research
Keywords: Information asymmetries field experiment adverse selection moral hazard development finance credit markets microfinance

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Find related papers by JEL classification:
C9 - Mathematical and Quantitative Methods - - Design of Experiments
D8 - Microeconomics - - Information, Knowledge, and Uncertainty
G2 - Financial Economics - - Financial Institutions and Services
G3 - Financial Economics - - Corporate Finance and Governance
O1 - Economic Development, Technological Change, and Growth - - Economic Development

This paper has been announced in the following NEP Reports:

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  2. Nidhiya Menon, 2004. "Consumption Smoothing in Micro Credit Programs," Development and Comp Systems 0403005, EconWPA. [Downloadable!]
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  7. Chiappori, Pierre Andre & Salanie, Bernard, 2002. "Testing Contract Theory: A Survey of Some Recent Work," CESifo Working Paper Series CESifo Working Paper No. , CESifo GmbH. [Downloadable!]
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  11. Amy Finkelstein & Kathleen McGarry, 2003. "Private Information and its Effect on Market Equilibrium: New Evidence from Long-Term Care Insurance," NBER Working Papers 9957, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  16. Nava Ashraf & Dean Karlan & Wesley Yin, 2006. "Tying Odysseus to the Mast: Evidence from a Commitment Savings Product in the Philippines," The Quarterly Journal of Economics, MIT Press, vol. 121(2), pages 635-672, May. [Downloadable!] (restricted)
    Other versions:
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  20. Mark M. Pitt & Shahidur R. Khandker, 1998. "The Impact of Group-Based Credit Programs on Poor Households in Bangladesh: Does the Gender of Participants Matter?," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 958-996, October. [Downloadable!] (restricted)
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  24. Paul S. Calem & Loretta J. Mester, 1995. "Consumer behavior and the stickiness of credit card interest rates," Working Papers 95-10, Federal Reserve Bank of Philadelphia.
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Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Amy Finkelstein & James Poterba, 2006. "Testing for Adverse Selection with "Unused Observables"," NBER Working Papers 12112, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  2. Nava Ashraf & James Berry & Jesse M. Shapiro, 2007. "Can Higher Prices Stimulate Product Use? Evidence from a Field Experiment in Zambia," NBER Working Papers 13247, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Karlan, Dean S. & Zinman, Jonathan, 2007. "Credit Elasticities in Less-Developed Economies: Implications for Microfinance," CEPR Discussion Papers 6071, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  4. Nava Ashraf & Dean Karlan & Wesley Yin, 2005. "Deposit Collectors," Working Papers 930, Economic Growth Center, Yale University. [Downloadable!]
    Other versions:
  5. 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. [Downloadable!]
    Other versions:
  6. William Adams & Liran Einav & Jonathan Levin, 2007. "Liquidity Constraints and Imperfect Information in Subprime Lending," NBER Working Papers 13067, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  7. Gine, Xavier & Jakiela, Pamela & Karlan, Dean & Morduch, Jonathan, 2006. "Microfinance games," Policy Research Working Paper Series 3959, The World Bank. [Downloadable!]
    Other versions:
    • Xavier Gine & Pamela Jakiela & Dean Karlan & Jonathan Morduch, 2006. "Microfinance Games," Working Papers 2102, The Field Experiments Website. [Downloadable!]
    • Dean Karlan & Xavier Gine & Jonathan Morduch & Pamela Jakiela, 2006. "Microfinance Games," Working Papers 936, Economic Growth Center, Yale University. [Downloadable!]
  8. Marianne Bertrand & Dean Karlan & Sendhil Mullainathan & Eldar Shafir & Johnathan Zinman, 2006. "What's Psychology Worth? A Field Experiment in the Consumer Credit Market," Natural Field Experiments 0021, The Field Experiments Website. [Downloadable!]
    Other versions:
  9. Dean Karlan & Jonathan Zinman, 2005. "Elasticities of Demand for Consumer Credit," Working Papers 926, Economic Growth Center, Yale University. [Downloadable!]
  10. Cull, Robert & Demirguc-Kunt, Asli & Morduch, Jonathan, 2006. "Financial performance and outreach : a global analysis of leading microbanks," Policy Research Working Paper Series 3827, The World Bank. [Downloadable!]
    Other versions:
  11. Giné, Xavier & Karlan, Dean S., 2007. "Group versus Individual Liability: A Field Experiment in the Philippines," CEPR Discussion Papers 6193, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  12. Dean Karlan & Jonathan Zinman, 2007. "Expanding Credit Access: Using Randomized Supply Decisions to Estimate the Impacts," Working Papers 956, Economic Growth Center, Yale University. [Downloadable!]
  13. Karlan, Dean S. & Zinman, Jonathan, 2007. "Expanding Credit Access: Using Randomized Supply Decisions to Estimate the Impacts," CEPR Discussion Papers 6407, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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This page was last updated on 2008-11-16.

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