Journal Article

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

Karlan, Dean, Zinman, Jonathan

2009

Overview

Information asymmetries are important in theory but difficult to identify in practice. We estimate the presence and importance of hidden information and hidden action problems in a consumer credit market using a new field experiment methodology. We randomized 58,000 direct mail offers to former clients of a major South African lender along three dimensions: (i) an initial \"offer interest rate\" featured on a direct mail solicitation; (ii) a \"contract interest rate\" that was revealed only after a borrower agreed to the initial offer rate; and (ii) a dynamic repayment incentive that was also a surprise and extended preferential pricing on future loans to borrowers who remained 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. Our setup distinguishes hidden information effects from selection on the offer rate (via unobservable risk and anticipated effort), from hidden action effects (via moral hazard in effort) induced by actual contract terms. We find strong evidence of moral hazard and weaker evidence of hidden information problems. A rough estimate suggests that perhaps 13% to 21% of default is due to moral hazard. Asymmetric information thus may help explain the prevalence of credit constraints even in a market that specializes in financing high-risk borrowers.

• Publisher: Blackwell Publishing Ltd,Econometric Society,Wiley-Blackwell
• Subject: Advanced selection / Adverse selection / Applications / Asset pricing / Asymmetric information / Asymmetry / Bond markets / Consumer behaviour / Consumer credit / Contract incentives / Contracts / Credit / Credit market / credit markets / development finance / Direct mail advertising / Econometrics / Exact sciences and technology / Experimental economics / Former clients / High risk / Information / information asymmetrics microfinance / Information asymmetry / Insurance, economics, finance / Interest rates / Lenders / Loan defaults / Loan rates / Loans / Markets / Mathematics / Moral hazard / Moral hazard models / Notes and Comments / Parametric inference / Probability and statistics / Sciences and techniques of general use / South Africa / Statistics / Studies / Sufficiency and information