DP6182 Observing Unobservables: Identifying Information Asymmetries with a Consumer Credit Field Experiment

Author(s): Dean S. Karlan, Jonathan Zinman
Publication Date: March 2007
Keyword(s): adverse selection, credit markets, development finance, field experiment, Information asymmetries, microfinance, moral hazard
JEL(s): C9, D8, G2, G3, O1
Programme Areas: Development Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6182

Information asymmetries are important in theory but difficult to identify in practice. We estimate the presence and 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) an initial "offer interest rate" featured on a direct mail solicitation; 2) a "contract interest rate" that was revealed only after a borrower agreed to the initial offer rate; and 3) a dynamic repayment incentive that 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 adverse selection from moral hazard effects on repayment, and thereby generates unique evidence on the existence and magnitudes of specific credit market frictions. We find evidence of moral hazard and weaker evidence for adverse selection. A rough calibration suggests that perhaps 7% to 16% of default is due to asymmetric information problems. Asymmetric information may help explain the prevalence of credit constraints even in a market that specializes in financing high-risk borrowers at very high rates.