Misfortune and Mistake: The Financial Conditions and Decision-making Ability of High-cost Loan Borrowers

The appropriateness of many high-cost loan regulations depends on whether demand is driven by financial conditions (“misfortunes”) or imperfect decisions (“mistakes”). Bank records from Iceland show borrowers have especially low liquidity just before getting a loan, but their spending is not especia...

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Bibliographic Details
Published inIDEAS Working Paper Series from RePEc
Main Authors Carvalho, Leandro, Olafsson, Arna, Silverman, Dan
Format Paper
LanguageEnglish
Published St. Louis Federal Reserve Bank of St. Louis 01.01.2019
Subjects
Decision making
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Summary:The appropriateness of many high-cost loan regulations depends on whether demand is driven by financial conditions (“misfortunes”) or imperfect decisions (“mistakes”). Bank records from Iceland show borrowers have especially low liquidity just before getting a loan, but their spending is not especially low in the days before the loan arrives and some spend a substantial fraction of the loans on seemingly inessential items. Borrowers exhibit lower decision-making ability (DMA) in linked choice experiments: 45% of loan dollars go to the bottom 20% of the DMA distribution. Standard determinants of demand do not explain this relationship, which is also mirrored by the relationship between DMA and an unambiguous “mistake.” Both “misfortune” and “mistake” thus appear to drive demand.