The Debt Payment Puzzle: An Experimental Investigation

95 Pages Posted: 6 Aug 2019 Last revised: 25 Oct 2023

See all articles by Hakan Ozyilmaz

Hakan Ozyilmaz

Toulouse School of Economics

Guangli Zhang

Saint Louis University; Saint Louis University - Sinquefield Center for Applied Economic Research

Date Written: October 23, 2023

Abstract

Why do borrowing individuals fail to repay their debt optimally? We design a diagnostic laboratory experiment where we rule out selection into debt and other confounds present in the field as potential explanations. We document that allocations are predominantly suboptimal even when individuals are attentive to interest rates, equipped with optimization ability, and face unrealistically high interest rate differences. We use revealed preference methods and identify mental accounting as the main mechanism through a novel parametric test of fungibility. We further investigate if optimization failures extend to an algebraically identical investment problem. Our structural estimates reveal debt frame substantially increases fungibility violations compared to an algebraically identical investment frame. Choice process data document the debt frame increases subjects’ focus on the irrelevant balance information. These results have implications on boundedly rational models of decision-making, the design of consumer protection policies, and the evolution of wealth inequality.

JEL Classification: C91, D14, D18, D91

Suggested Citation

Ozyilmaz, Hakan and Zhang, Guangli, The Debt Payment Puzzle: An Experimental Investigation (October 23, 2023). Available at SSRN: https://ssrn.com/abstract=3430746 or http://dx.doi.org/10.2139/ssrn.3430746

Hakan Ozyilmaz (Contact Author)

Toulouse School of Economics ( email )

Place Anatole-France
Toulouse Cedex, F-31042
France

Guangli Zhang

Saint Louis University ( email )

3700 West Pine Mall Blvd. Fusz Hall, 358
St. Louis, MO 63103
United States

HOME PAGE: http://https://sites.google.com/view/guanglizhang

Saint Louis University - Sinquefield Center for Applied Economic Research ( email )

3700 West Pine Mall Blvd. Fusz Hall, 358
St. Louis, MO 63103
United States

HOME PAGE: http://https://sites.google.com/view/guanglizhang

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