An Experimental Analysis of the Demand for Payday Loans

Abstract

The payday loan industry is one of the fastest growing segments of the consumer financial services market in the United States. We design an environment similar to the one that payday loan customers face and then conduct a laboratory experiment to examine what effect, if any, the existence of payday loans has on individuals’ abilities to manage and to survive financial setbacks. Our primary objective is to examine whether access to payday loans improves or worsens the likelihood of financial survival in our experiment. We also test the degree to which people’s use of payday loans affects their ability to survive financially. We find that payday loans help the subjects to absorb expenditure shocks and therefore survive financially. However, subjects whose demand for payday loans exceeds a certain threshold level are at a greater risk than a corresponding subject in the treatment in which payday loans do not exist.

Access to Short-Term Credit and Consumption Smoothing within the Paycycle

“…In the survey conducted by Elliehausen and Lawrence (2001), many payday loan borrowers claim that payday loans are helpful and should not be restricted in any way other than with a cap on fees while others ask for greater restrictions to prevent themselves from over borrowing. Wilson et al (2010) find, in an experimental setting, that payday loan instruments assist many subjects in surviving financial setbacks while others suffer compared to subjects with no loan access. This paper provides evidence that payday loans, even with their cost, can function like more mainstream credit and can provide consumption smoothing benefits.…”

Payday Loan Use and Consumer Well-Being: What Consumers and Social Workers Need to Know About Payday Loans

“…Further, payday loan customers' loan applications would have likely been rejected had they applied at a mainstream financial institution (Agarwal & Bos, 2011 A body of recent correlational and experimental research was selected to review the consequences of using payday loans. Although consensus on whether payday loans help or harm consumers remains elusive, the empirical findings can be summarized into two categories: (1) welfare improving by smoothing income and expenditure shocks (e.g., Karlan & Zinman, 2010;Morgan & Strain, 2008;Morse, 2011;B. Wilson, Findlay, Meehan, Welford, & Schurter, 2010;Zinman, 2010) and (2) welfare deteriorating by exacerbating financial distress (e.g., D. Campbell, Martinez-Jerez, & Tufano, 2008;Carrell & Zinman, 2008;Han & Li, 2011;Melzer, 2011;Skiba & Tobacman, 2011).…”

“…Wilson et al (2010) measured the number of months participants could financially survive, defined as the ability to absorb expenditure shocks. The existence of payday loans helped the participants to absorb expenditure shocks.…”

“…However, payday loans harmed the participants whose demands for payday loans exceeded a certain threshold level (taking out more than 10 loans) and reduced these participants' probability of financial survival (B. Wilson et al, 2010).…”

Restricting consumer credit access: Household survey evidence on effects around the Oregon rate cap

“…But several other studies suggest otherwise. They find that, on average, access to expensive consumer loans helps borrowers smooth negative shocks (Morse 2007;Wilson et al 2008), make productive investments in job retention (Karlan and Zinman 2008), or better manage liquidity to alleviate financial distress (Morgan and Strain 2008). These findings suggest that restricting access will harm borrowers by preventing them from financing valuable investment and consumption smoothing opportunities.…”