Making Firms Liable for Consumers' Mistaken Beliefs: Theoretical Model and Empirical Applications to the U.S. Mortgage and Credit Card Markets

39 Pages Posted: 28 Apr 2015 Last revised: 29 Jun 2017

Date Written: June 27, 2017

Abstract

I show that an introduction of a liability on firms, proportional to the difference between consumers' beliefs and the effective terms of purchase/contract, can improve both social welfare and consumer surplus, depending on the relative magnitudes of: 1) decrease in the gap between the beliefs and the effective terms of the contract due to the introduction of the liability, 2) output decrease or price increase, and 3) efficiency of administering the liability (and the amount transferred). I do not find statistically significant evidence of (2) in two examples of instituting a similar liability: when several large U.S. credit card issuers dropped mandatory arbitration clauses (that effectively precluded class action lawsuits) and when U.S. residential mortgage creditors became liable for failing to consider a borrower's future ability to repay the mortgage, suggesting that these events improved consumer surplus and might have improved social welfare.

Note: The analysis of the mortgage market is preliminary and the description of the results is based on different datasets than those that are described in the text. I will update the text (and, potentially, the results) based on the datasets described when they become publicly available around September 2015.

Keywords: behavioral bias, class action, ability to pay, ability to repay, mortgage, credit cards

JEL Classification: D18, D83, D86, G21, K12, K23, K41

Suggested Citation

Alexandrov, Alexei, Making Firms Liable for Consumers' Mistaken Beliefs: Theoretical Model and Empirical Applications to the U.S. Mortgage and Credit Card Markets (June 27, 2017). Available at SSRN: https://ssrn.com/abstract=2599424 or http://dx.doi.org/10.2139/ssrn.2599424

Alexei Alexandrov (Contact Author)

Independent

No Address Available

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