Observing Unobservables: Identifying Information Asymmetries with a Consumer Credit Field Experiment

This paper estimates the empirical importance of adverse selection and moral hazard in a consumer credit market using a new field experiment methodology. The paper takes the reader through an experiment where 58,000 direct mail offers issued by a major South African lender were randomized along three dimensions:

• The initial "offer interest rate" appearing on direct mail solicitations;
• A "contract interest rate" equal to, or less than, the offer interest rate, and revealed to the over 4,000 borrowers who agreed to the initial offer rate;
• A dynamic repayment incentive that extends preferential pricing on future loans to borrowers who remain in good standing.

The paper explains how the three randomizations, combined with complete knowledge of the lender's information set, permit identification of specific types of private information problems.

The paper also states that specifically, the setup distinguishes adverse selection from moral hazard effects on repayment, and thereby generates unique evidence on the existence and magnitudes of specific credit market failures. The experiment concludes that:

• There is both adverse selection among women and moral hazard, predominantly among men, though this motivates further research, both empirical and theoretical;
• About 20% of default is due to asymmetric information problems, which in turn, helps explain the prevalence of credit constraints even in a market that specializes in financing high risk borrowers at very high rates.