Exploiting Naïvete about Self-Control in the Credit Market

2010/12/01 by Paul Heidhues, Botond Kőszegi · 435 citations
Business, Management and Accounting · Economics, Econometrics and Finance · #Consumption (sociology) #Credit card #Economic theories and models #Economics #Finance #Financial Literacy, Pension, Retirement Analysis #Housing Market and Economics #Loan #Market economy #Microeconomics #Monetary economics #Payment #Welfare

paper · doi:10.1257/aer.100.5.2279

published in American Economic Review 100(5), 2279-2303 (American Economic Association)

openalex publication_date 2010/12/01 · openalex created_date 2025/10/10 · openalex updated_date 2026/08/04

Abstract

We analyze contract choices, loan-repayment behavior, and welfare in a model of a competitive credit market when borrowers have a taste for immediate gratification. Consistent with many credit cards and subprime mortgages, for most types of nonsophisticated borrowers the baseline repayment terms are cheap, but they are also inefficiently front loaded and delays require paying large penalties. Although credit is for future consumption, nonsophisticated consumers overborrow, pay the penalties, and back load repayment, suffering large welfare losses. Prohibiting large penalties for deferring small amounts of repayment—akin to recent regulations in the US credit-card and mortgage markets—can raise welfare. (JEL D14, D18, D49, D86)

Citations

• Paying Not to Go to the Gym
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