The Opportunity Cost of Debt Aversion

Abstract

We provide evidence of the existence of debt aversion and its negative implications for financial decisions. In a new experimental design where subjects are assigned debt randomly, we quantify the opportunity cost of subjects’ debt-biased decisions. One-third of our participants neglect high returns and focus instead on debt repayments. In addition, borrowing to invest is 50 percent less likely when it leads to indebtedness. On average, participants perceive $1 in debt as equivalent to $1.03 in savings. Hence, a debt-averse agent will undertake a 10 percent guaranteed investment only if the cost of borrowing does not exceed 6.80 percent.

Keywords: debt aversion, household finance, experiment, financial frames

JEL Classification: C91, D14, D91