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Observing Unobservables: Identifying Information Asymmetries with a Consumer Credit Field Experiment
Last registered on July 26, 2016

Pre-Trial

Trial Information
General Information
Title
Observing Unobservables: Identifying Information Asymmetries with a Consumer Credit Field Experiment
RCT ID
AEARCTR-0001241
Initial registration date
July 26, 2016
Last updated
July 26, 2016 2:56 PM EDT
Location(s)
Region
Primary Investigator
Affiliation
Northwestern University
Other Primary Investigator(s)
PI Affiliation
Dartmouth College
Additional Trial Information
Status
Completed
Start date
2003-07-01
End date
2003-10-31
Secondary IDs
Abstract
Information asymmetries are important in theory but difficult to identify in practice. We estimate the presence and importance of hidden information and hidden action problems in a consumer credit market using a new field experiment methodology. We randomized 58,000 direct mail offers to former clients of a major South African lender along three dimensions: (i) an initial “offer interest rate” featured on a direct mail solicitation; (ii) a “contract interest rate” that was revealed only after a borrower agreed to the initial offer rate; and (ii) a dynamic repayment incentive that was also a surprise and extended preferential pricing on future loans to borrowers who remained in good standing. These three randomizations, combined with complete knowledge of the Lender’s information set, permit identification of specific types of private information problems. Our setup distinguishes hidden information effects from selection on the offer rate (via unobservable risk and anticipated effort), from hidden action effects (via moral hazard in effort) induced by actual contract terms. We find strong evidence of moral hazard and weaker evidence of hidden information problems. A rough estimate suggests that perhaps 13% to 21% of default is due to moral hazard. Asymmetric information thus may help explain the prevalence of credit constraints even in a market that specializes in financing high-risk borrowers.
External Link(s)
Registration Citation
Citation
Karlan, Dean and Jonathan Zinman. 2016. "Observing Unobservables: Identifying Information Asymmetries with a Consumer Credit Field Experiment." AEA RCT Registry. July 26. https://doi.org/10.1257/rct.1241-1.0.
Former Citation
Karlan, Dean and Jonathan Zinman. 2016. "Observing Unobservables: Identifying Information Asymmetries with a Consumer Credit Field Experiment." AEA RCT Registry. July 26. https://www.socialscienceregistry.org/trials/1241/history/9687.
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Experimental Details
Interventions
Intervention(s)
We sought to determine the presence and relative importance of "hidden information" and "hidden action" effects to explain the high rate of default amongst high-risk borrowers in South Africa. In the summer of 2003, the partner lender mailed a brochure to 57,533 former clients with a good repayment history offering a randomly-assigned interest rate, which was conditional on their previous designation as low, medium, or high-risk borrowers. High-risk borrowers were offered high rates, low-risk borrowers low rates. In all, 5028 clients accepted the offer, of which 4348 were approved for a loan.

While meeting with loan officers to determine the conditions of their loan, 41 percent of borrowers were randomly selected to receive an offer for a new interest rate (the contract rate) that was lower than the original offer rate they received in the brochure. After the loan contracts were finalized, a random 47 percent of the borrowers who had received the lower contract rate were informed that they would receive that same low rate on all future loans for the next year as long as they repaid the initial loan on time. The guaranteed future rate was designed to give borrowers a greater incentive to repay their initial loan.

By randomizing the interest rate along three dimensions(i) the initial offer rate featured in the mailer, (ii) the contract rate that was revealed only after the borrower agreed to the initial offer rate, and (iii) the future rate that extended preferential pricing on future loans to borrowers who remained in good standing, the researchers essentially created five different groups whose repayment rates could be compared to determine whether hidden information or hidden action effects have a larger impact on loan repayment. The following treatment groups were created:
- Group 1: High offer rate, high contract rate, no low future rate
- Group 2: High offer rate, low contract rate, guaranteed low future rate
- Group 3: High offer rate, low contract rate, no low future rate
- Group 4: Low offer rate, low contract rate, guaranteed low future rate
- Group 5: Low offer rate, low contract rate, no low future rate
Intervention Start Date
2003-07-01
Intervention End Date
2003-10-31
Primary Outcomes
Primary Outcomes (end points)
- Probability of loan repayment (default rate)
Primary Outcomes (explanation)
Secondary Outcomes
Secondary Outcomes (end points)
Secondary Outcomes (explanation)
Experimental Design
Experimental Design
The experiment was conducted in three waves: July, September, and October 2003. In each wave clients were randomly assigned three interest rates conditional on their observable risk category. Rate ranged from an upper bound of the prior interest rate for each individual to a lower bound of 3.25% per month. The offer rate was featured on the direct mailer. The contract and future rates were only revealed to clients and loan officers if the client took up the offer (i.e., applied), and after the loan officer completed her initial underwriting. Our design contains built-in integrity checks for whether the contract and future rate were indeed surprises: both client take-up and loan officer approve/reject decisions were uncorrelated with the surprise rates. Nor were there any instances of clients applying for the loan, being approved, and then not taking out the loan. This fact further corroborates that the contract rate and dynamic repayment incentive were surprises; i.e., that borrowers made take-up decisions with reference to the offer rate only.

5028 (8.7%) clients took up the offer by applying for a loan. Clients applied by entering a branch office and filling out an application in person with a loan officer. Loan applications were taken and assessed as per the lender’s normal underwriting procedures. The loan application process took at most one hour, typically less. Loan officers first updated observable information (current debt load, external credit report, and employment information) and decide whether to offer any loan based on their updated risk assessment. 4348 (86.5%) of applicants were approved. Next loan officers decided the maximum loan size and maturity for which applicants qualified. Each loan supply decision was made “blind” to the experimental rates; i.e., the credit, loan amount, and maturity length decisions were made as if the individual were applying to borrow at the normal rate dictated by her observable risk class.

After clients choose an allowable loan size and maturity, special software revealed the contract rate in the 41% cases that it was lower than the offer rate (otherwise no mention was made of a potentially lower rate). Loan officers were instructed to present the lower contract rate as simply what the computer dictated, not as part of a special promotion or anything particular to the client. Due to operational constraints, clients were then permitted to adjust their desired loan size following the revelation of the contract rate. In theory, endogenizing loan size in this fashion can work against identifying moral hazard on the contract rate (since a lower contract rate strengthens repayment incentives ceteris paribus, but might induce choice of a higher loan size that weakens repayment incentives). In practice, however, only about 3% of borrowers who received a lower contract than offer rate changed their loan demand after the contract rate was revealed.

Last, 47% of clients were randomly assigned and informed of a dynamic incentive future rate in which clients received the same low contract interest rate on all future loans for one year as long as they remained in good standing with the lender. This explicitly raised the benefits of repaying the initial loan on time (or equivalently the cost of defaulting) in the 98% of cases where the contract rate was less than the lender’s normal rate. The average discount embodied in the contract rate, and hence future rate, was substantial: an average of 350 basis points off the monthly rate. Moreover, the lender’s prior data suggested that, conditional on borrowing once, a client would borrow again within a year more than half the time. Clients not receiving the dynamic incentive obtained a contract rate for just the first loan (which had only a 4-month maturity in 80% of the cases). Clients were informed of the future rate by the branch manager only after all paperwork had been completed and all other terms of the loan were finalised.
Experimental Design Details
Randomization Method
randomization done in office by a computer using Stata
Randomization Unit
Individual
Was the treatment clustered?
No
Experiment Characteristics
Sample size: planned number of clusters
5028 loan applicants
Sample size: planned number of observations
5028 loan applicants
Sample size (or number of clusters) by treatment arms
multi-arm, see paper and data
Minimum detectable effect size for main outcomes (accounting for sample design and clustering)
IRB
INSTITUTIONAL REVIEW BOARDS (IRBs)
IRB Name
IRB Approval Date
IRB Approval Number
Post-Trial
Post Trial Information
Study Withdrawal
Intervention
Is the intervention completed?
Yes
Intervention Completion Date
October 31, 2003, 12:00 AM +00:00
Is data collection complete?
Yes
Data Collection Completion Date
October 31, 2003, 12:00 AM +00:00
Final Sample Size: Number of Clusters (Unit of Randomization)
4348 loan recipients
Was attrition correlated with treatment status?
Final Sample Size: Total Number of Observations
4348 loan recipients
Final Sample Size (or Number of Clusters) by Treatment Arms
Data Publication
Data Publication
Is public data available?
No
Program Files
Program Files
Reports and Papers
Preliminary Reports
Relevant Papers
Abstract
Information asymmetries are important in theory but difficult to identify in practice. We estimate the presence and importance of hidden information and hidden action problems in a consumer credit market using a new field experiment methodology. We randomized 58,000 direct mail offers to former clients of a major South African lender along three dimensions: (i) an initial “offer interest rate” featured on a direct mail solicitation; (ii) a “contract interest rate” that was revealed only after a borrower agreed to the initial offer rate; and (ii) a dynamic repayment incentive that was also a surprise and extended preferential pricing on future loans to borrowers who remained in good standing. These three randomizations, combined with complete knowledge of the Lender’s information set, permit identification of specific types of private information problems. Our setup distinguishes hidden information effects from selection on the offer rate (via unobservable risk and anticipated effort), from hidden action effects (via moral hazard in effort) induced by actual contract terms. We find strong evidence of moral hazard and weaker evidence of hidden information problems. A rough estimate suggests that perhaps 13% to 21% of default is due to moral hazard. Asymmetric information thus may help explain the prevalence of credit constraints even in a market that specializes in financing high-risk borrowers.
Citation
Karlan, Dean, and Jonathan Zinman. 2009. "Observing Unobservables: Identifying Information Asymmetries with a Consumer Credit Field Experiment." Econometrica 77 (6): 1993-2008.