The Credit Behavior of Households - A Behavioral Approach

Abstract

The access to credit is generally seen as an important ingredient for development. However, over the last years reports on families contracting excessive debt and falling into credit traps have also increased. In this paper I develop a model of family credit behavior based on insights from behavioral economics. I particularly consider phenomena like keeping-up-with-the-Joneses, a limited time horizon, gain-loss-asymmetry and over-confidence. The model coherently reproduces the level and the distribution of debt over for all socioeconomic groups. The results suggest that the use of a reference-group dependent utility and the precise definition of the reference group are crucial elements in explaining the debt levels of the different socio-economic groups. A policy simulation shows that reducing the amount of available credit (ceiling) might have beneficial effects on consumption and consumption inequality. In this respect, the findings contradict the idea that access to credit is positive for families in all situations.

Keywords: household finance, access to credit, credit trap, prospect theory, behavioral economics, inequality

JEL Classification: C63, D03, D14, D31, D91, G02