Effects of Bonus on the Demand for Auto Loans and the Long-Term Consequences
40 Pages Posted: 25 Jan 2018
Date Written: January 12, 2018
Using a large consumer panel data set of both credit and employment profiles, we study the demand for auto loans among consumers in response to receiving bonus payments. While bonus payments represent a one-time income increase, auto loans lead to a significant financial burden in the long term. We find an economically meaningful increase in auto loan demand around the month of receiving a bonus, even for low-income, subprime-credit-score consumers who only receive a small bonus. To explore the underlying mechanism that drives the demand, we test predictions from the permanent income hypothesis. Contrary to the theory prediction, the increase in auto loan demand is significant when the bonus is likely to be anticipated. Furthermore, the effect is robust for individuals who are unlikely to have liquidity constraints. These findings, however, can be explained by the mental accounting theory. Finally, we show that auto loans induced by bonus have a significantly higher delinquency rate than loans that originate at other times. This primarily comes from consumers with low incomes or subprime credit scores. Our findings can help financial institutions identify consumers who have a need for auto loans and those who have a higher delinquency risk in the future.
Keywords: Consumer Financial Decision Making, Mental Accounting, PIH
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