Payday Loans, Uncertainty and Discounting: Explaining Patterns of Borrowing, Repayment, and Default

36 Pages Posted: 24 Dec 2008

See all articles by Paige Marta Skiba

Paige Marta Skiba

Vanderbilt University - Law School

Jeremy Tobacman

Alfred Lerner College of Business and Economics, University of Delaware

Date Written: August 21, 2008

Abstract

Ten million American households borrowed on payday loans in 2002. Typically, to receive two weeks of liquidity from these loans households paid annualized (compounded) interest rates over 7000%. Using an administrative dataset from a payday lender, we seek to explain demand-side behavior in the payday loan market. We estimate a structural dynamic programming model that includes standard features like liquidity constraints and stochastic income, and we also incorporate institutionally realistic payday loans, default opportunities, and generalizations of the discount function. Method of Simulated Moments estimates of the key parameters are identified by two novel pieces of evidence. First, over half of payday borrowers default on a payday loan within one year of their first loans. Second, defaulting borrowers have on average already repaid or serviced five payday loans, making interest payments of 90% of their original loan's principal. Such costly delay of default, we find, is most consistent with partially naive quasi-hyperbolic discounting, and we statistically reject nested benchmark alternatives.

Keywords: payday lending, payday loan, hyperbolic discounting, default

JEL Classification: D12, H31

Suggested Citation

Skiba, Paige Marta and Tobacman, Jeremy, Payday Loans, Uncertainty and Discounting: Explaining Patterns of Borrowing, Repayment, and Default (August 21, 2008). Vanderbilt Law and Economics Research Paper No. 08-33. Available at SSRN: https://ssrn.com/abstract=1319751 or http://dx.doi.org/10.2139/ssrn.1319751

Paige Marta Skiba (Contact Author)

Vanderbilt University - Law School ( email )

131 21st Avenue South
Nashville, TN 37203-1181
United States
615-322-1958 (Phone)

Jeremy Tobacman

Alfred Lerner College of Business and Economics, University of Delaware ( email )

Newark, DE 19716
United States

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