Debt Aversion: Theory and Measurement

Abstract

Debt aversion can have severe adverse effects on financial decision-making. We propose a model of debt aversion, and design an experiment involving real debt and saving contracts, to elicit and jointly estimate debt aversion with preferences over time, risk and losses. Structural estimations reveal that the vast majority of participants (89%) are debt averse, and that this has a strong impact on choice. We estimate the "borrowing premium" -the compensation a debt averse person would require to accept getting into debt -to be around 16% of the principal for our average participant.