Forbearance vs. Interest Rates: Experimental Tests of Liquidity and Strategic Default Triggers

37 Pages Posted: 14 Dec 2021 Last revised: 27 Feb 2024

See all articles by Deniz Aydin

Deniz Aydin

Washington University in St. Louis - John M. Olin Business School

Date Written: December 10, 2021

Abstract

I use the random assignment of debt relief policies in a large-scale field experiment to test default models emphasizing liquidity and strategic behavior. In contrast to liquidity being the sole trigger, borrowers respond differently to a dollar reduction in current payments when delivered through forbearance or interest rate reduction: forbearance reduces payments twice as much, whereas delinquencies are more responsive to a rate reduction. Compatible with strategic behavior, borrowers default in response to changes in future payments orthogonal to solvency and liquidity. Compatible with the endogeneity of triggers, whether forbearance or interest rates are more effective, and defaults are strategic is tightly linked to borrower balance sheets. I characterize a single strategic default trigger whose location is influenced by distress, precaution, and assets. The findings have implications for targeting loan modifications and modeling the pass-through of interest rates.

Keywords: debt relief, forbearance, interest rates, solvency, liquidity, strategic behavior, present value, randomized field experiment

JEL Classification: G51, D15, E63

Suggested Citation

Aydin, Deniz, Forbearance vs. Interest Rates: Experimental Tests of Liquidity and Strategic Default Triggers (December 10, 2021). Olin Business School Center for Finance & Accounting Research Paper No. Forthcoming, Available at SSRN: https://ssrn.com/abstract=3982587 or http://dx.doi.org/10.2139/ssrn.3982587

Deniz Aydin (Contact Author)

Washington University in St. Louis - John M. Olin Business School ( email )

One Brookings Drive
St. Louis, MO 63130
United States

HOME PAGE: http://sites.wustl.edu/denizaydin

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