2008 Small Grants Competition: Financial Risk, Assets, and Poverty
Funded research
Adair Morse, University of Chicago; and Marianne Bertrand, University of Chicago
Financial Literacy, Cognitive Biases and Payday Lending
Description
Our objective in this research is to provide some new insights on the relative merits of two opposite views of payday borrowing—that individuals borrow rationally to smooth income/expenditure shocks or that individuals’ borrowing reflects one or multiple cognitive limitation(s) (e.g., an inability to understand the fee structure, a lack of self-control, overconfidence about repayment ability, etc.).
To accomplish this goal we have obtained unique access to a random subset of customers of one the largest payday lender in U.S. We survey these customers and document their demographic profile, their level of self-control, and their expectations about their ability to repay these loans. We then perform a simple randomized experiment which will allow us to directly estimate the effect of financial literacy and biased expectations (if any) on individuals’ ability to repay payday loans quickly. In addition we interact this experiment with a treatment to empower thrift by providing saving planners to a portion of the sample.
After two months, we telephone customers and ask them a set of questions concerning the loan’s success as well as their income flows, expenditures and borrowing history since taking up the loan. We compare these results with a download of the full records of the loan outcome and history from the lender to study any treatment effects. The research offers a unique opportunity to get inside the payday lending industry, better understand the circumstances under which people borrow at high rates, and determine whether further policy intervention in this industry has the potential to be welfare-enhancing.
