Precommitments for Financial Self-Control: Evidence Before and After the 2003 Korean Credit Crisis
Event details
| Date | 20.02.2015 |
| Hour | 10:30 › 12:00 |
| Speaker | John RUST (University of Maryland) |
| Location | |
| Category | Conferences - Seminars |
We analyze a new data set on installment borrowing decisions of two samples of customers of a credit card company drawn before and after the 2003 Korean credit crisis. In an attempt to increase its market share, the company more or less randomly offers its customers free installments, i.e. opportunities to finance credit card purchases via installment loans at a zero percent interest rate for durations up to twelve months. We exploit these offers as a quasi-random field experiment to better understand consumer demand for credit. Although there is considerable customer-level heterogeneity in installment usage, we show that following the credit crisis, the average take-up rate of free installment offers fell dramatically: customers chose them only 20% of time they were offered. Further, we provide evidence of pervasive precommitment behavior by individuals who decided to take free installment offers. For example, we estimate that of the subset of 10 month free installment offers that are taken, only 18% are taken for the full 10 month term allowed under the offer. In the other 82% of these offers, customers precommit at the time of purchase to pay the balance in fewer than 10 installments. Thus, only 3.6% (18% × 20%) of all 10 month free installment offers are taken for the full 10 month duration. It is challenging to explain this behavior using standard expected utility models since there are no pre-payment penalties and the transactions costs involved in choosing these loans are small: rational customers should take every installment offer for the maximum allowed term when the interest rate is 0%. One explanation for this behavior is that consumers have financial self-control problems and resist the temptation to take interest-free loan offers. If they absolutely must borrow, most consumers choose repayment terms that are shorter than the maximum allowed term to avoid becoming excessively indebted. We find that free installment offers did not shift much before or after the 2003 credit crisis: instead, consumers were much more likely to take these offers before the crisis, and much less likely to take them after the crisis. One interpretation is that consumers experienced a lack of financial self-control prior to the crisis, and dramatically adjusted their behavior to avoid the “temptation” of interest-free loans in the post-crisis period.
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