Relational foundations of an unequal consumer credit market: Symbiotic ties between banks and payday lenders

Banks have financially supported payday lenders for decades. In this article I qualitatively demonstrate how these financial relationships have reinforced and expanded a bifurcated consumer credit market, and why these relationships matter for consumer access to financial services. I use archival financial documents from publicly traded payday lending companies between 1996 and 2014, available through the Securities and Exchange Commission, to construct the bank-payday lender network and reveal motivations for these financial relationships. I find that bank-payday lender relationships are sustained over many years, and that these relationships are mutually beneficial, enabling payday lender expansion and providing a way for banks to quietly profit from high-interest lending in the face of other regulatory constraints. Further, I show that these relationships have significantly reshaped the consumer credit market over the past two decades. I conclude by considering broader implications of symbiotic institutional relationships in contemporary markets.     

Payday Loan and Pawnshop Usage: The Impact of Allowing Payday Loan Rollovers

Millions of US households rely on payday loans and pawnshops for short‐term credit. Payday loan interest rates are as high as 25% per 2‐ to 4‐week loans and individuals use a post‐dated check to secure the loan. Pawnshop usage is available for anyone with collateral. This article examines whether individuals using payday loans in states where rollovers are allowed are more likely to also use pawnshops together with payday loans. I find that this is true for individuals who make less than $30,000, but it does not hold for those with higher levels of income. There may be some complementary relationships between payday loan rollovers and pawnshops for these lower‐income individuals. These results are important when considering whether to allow payday loan rollovers.     

Consumer Credit Risk and Pricing

Previous academic studies viewed borrower rejection as a sign of market imperfections in the consumer credit markets, but this view was based upon the assumption that differences in the levels of borrower creditworthiness could not be accurately identified. Today, it is possible to differentiate between types of borrowers, and riskier borrowers can participate in credit markets if they are willing to pay relatively higher borrowing costs. Hence, a more critical issue concerning the performance of these markets should be whether loan prices correctly reflect the level of borrower credit risk. This paper reexamines consumer participation in credit markets looking specifically at issues related to the pricing of borrowers of different credit risk.     

On The Reference Point Effect of Reserve and Buy It Now Prices

In recent years, a trend in retail pricing has been to give consumers greater autonomy in setting their own prices, be it through auctions or other forms of participative pricing. Such consumer pricing autonomy often requires the seller to set limits in the form of price floors and price ceilings. Price floors and ceilings in our auction settings are referred to as reserve prices (RP) and Buy It Now (BIN) prices, respectively. We examine the effect of RP and BIN presence and magnitude on the number of bidders and ending price. Using auctions, we uncover consumers’ willingness to pay (WTP) through bids. WTP is malleable through reference cues. Our focus is on two such cues: BINs and RPs. Results of two field studies, augmented with a laboratory study, show that both BINs and RPs result in lower bidder entry, but have an overall positive effect on ending price. Furthermore, results show that RP is more effective than a comparable BIN magnitude and that these two pricing cues are substitutes. The study design allows the authors to rule out alternative explanations. Open RP and BIN's effect on ending price is due to a reference point effect rather than a price truncation effect. Thus, retailers can increase WTP through changing these reference cues and exploit a richer choice set over which to shape a malleable WTP. The quantification of the interaction between RP and BIN gives managers the ability to jointly take advantage of both RP and BIN.     

Viability and Equilibrium in Securities Markets with Frictions

In this paper we study some foundational issues in the theory of asset pricing with market frictions. We model market frictions by letting the set of marketed contingent claims (the opportunity set) be a convex set, and the pricing rule at which these claims are available be convex. This is the reduced form of multiperiod securities price models incorporating a large class of market frictions. It is said to be viable as a model of economic equilibrium if there exist price-taking maximizing agents who are happy with their initial endowment, given the opportunity set, and hence for whom supply equals demand. This is equivalent to the existence of a positive lineaar pricing rule on the entirespace of contingent claims—an underlying frictionless linear pricing rule—that lies below the convex pricing rule on the set of marketed claims. This is also equivalent to the absence of asymptotic free lunches—a generalization of opportunities of arbitrage. When a market for a nonmarketed contingent claim opens, a bid-ask price pair for this claim is said to be consistent if it is a bid-ask price pair in at least a viable economy with this extended opportunity set. If the set of marketed contingent claims is a convex cone and the pricing rule is convex and sublinear, we show that the set of consistent prices of a claim is a closed interval and is equal (up to its boundary) to the set of its prices for all the underlying frictionless pricing rules. We also show that there exists a unique extended consistent sublinear pricing rule—the supremum of the underlying frictionless linear pricing rules—for which the original equilibrium does not collapse when a new market opens, regardless of preferences and endowments. If the opportunity set is the reduced form of a multiperiod securities market model, we study the closedness of the interval of prices of a contingent claim for the underlying frictionless pricing rules.     

Impact of Financial Education Mandates on Younger Consumers' Use of Alternative Financial Services

Over one‐quarter of American adults used credit‐based alternative financial services (AFS) in the past five years, which carry a typical APR of 300%. Young adults are especially more likely to use AFS yet are also more likely to be exposed to personal finance education in schools. In this study, I use data from pooled 2012 and 2015 waves of National Financial Capability Study to examine whether state‐mandated financial education impacts young adults' use of AFS. I find that financial education mandates significantly reduced the likelihood and frequency of payday borrowing in particular. Additionally, I show that exposure to required personal finance courses could affect payday borrowing through increased financial literacy and improved financial planning practices. These findings suggest that policymakers and other stakeholders need to understand the full benefits of financial education when making cost–benefit analysis comparisons as to whether or not to implement.     

Ethical Commitments and Credit Market Regulations

Journal of Business Ethics - In this paper we examine some of the economic and ethical consequences of different credit market regulations, including usury laws, complete prohibition of interest...     

The Chinese warrant bubble: A fundamental analysis

We investigate the information content in Chinese warrant prices based on an option pricing framework that incorporates short‐selling and margin‐trading constraints in the underlying stock market. We show that Chinese warrant prices can be explained under this pricing framework. On the basis of this new model, we develop a price deviation measure to quantify stock market investors' unobserved demand for short selling or margin trading due to market constraints. We find that warrant‐price deviations are driven by underlying stock valuation to a great extent. Chinese warrant prices, save for the time around expiration dates, are better characterized as derivatives than as pure bubbles.     

Intertemporal price discrimination with forward-looking consumers: Application to the US market for console video-games

Firms in durable good product markets face incentives to intertemporally price discriminate, by setting high initial prices to sell to consumers with the highest willingness to pay, and cutting prices thereafter to appeal to those with lower willingness to pay. A critical determinant of the profitability of such pricing policies is the extent to which consumers anticipate future price declines, and delay purchases. I develop a framework to investigate empirically the optimal pricing over time of a firm selling a durable-good product to such strategic consumers. Prices in the model are equilibrium outcomes of a game played between forward-looking consumers who strategically delay purchases to avail of lower prices in the future, and a forward-looking firm that takes this consumer behavior into account in formulating its optimal pricing policy. The model outlines first, a dynamic model of demand incorporating forward-looking consumer behavior, and second, an algorithm to compute the optimal dynamic sequence of prices given these demand estimates. The model is solved using numerical dynamic programming techniques. I present an empirical application to the market for video-games in the US. The results indicate that consumer forward-looking behavior has a significant effect on optimal pricing of games in the industry. Simulations reveal that the profit losses of ignoring forward-looking behavior by consumers are large and economically significant, and suggest that market research that provides information regarding the extent of discounting by consumers is valuable to video-game firms.

NO‐ARMAGEDDON MEASURE FOR ARBITRAGE‐FREE PRICING OF INDEX OPTIONS IN A CREDIT CRISIS

In this work, we consider three problems of the standard market approach to credit index options pricing: the definition of the index spread is not valid in general, the considered payoff leads to a pricing which is not always defined, and the candidate numeraire for defining a pricing measure is not strictly positive, which leads to a nonequivalent pricing measure. We give a solution to the three problems, based on modeling the flow of information through a suitable subfiltration. With this we consistently take into account the possibility of default of all names in the portfolio, that is neglected in the standard market approach. We show on market inputs that, while the pricing difference can be negligible in normal market conditions, it can become highly relevant in stressed market conditions, like the situation caused by the credit crunch.     

Counter‐Credit‐Risk Yield Spreads: A Puzzle in China's Corporate Bond Market

In this paper, using China's risk‐free and corporate zero yields together with aggregate credit risk measures and various control variables from 2006 to 2013, we document a puzzle of counter‐credit‐risk corporate yield spreads. We interpret this puzzle as a symptom of the immaturity of China's credit bond market, which reveals a distorted pricing mechanism latent in the fundamental of this market. We also find interesting results about relationships between corporate yield spreads and interest rates and risk premia and the stock index, and these results are somewhat attributed to this puzzle.     

Does Payday Lending Hurt Food Security in Low‐Income Households?

During the study period of 2005–2011, household food insecurity rates as well as regulations over payday lending industry increased in the United States. This study evaluates the association between access to payday lending and the risk of food insecurity using cross‐sectional samples of low‐income households from the 2005 to 2011 Food Security Supplements of the Current Population Survey. The study uses county‐level payday lender density, state‐level legislative status, and county border indicators of cross‐state payday access to examine how payday lender availability affects household food insecurity. The findings suggest that access to payday lending, which may be presumed to provide convenient short‐term credit to underserved consumers, increases the likelihood of household food insecurity by 2.8–6.0 percentage points in absolute terms. Furthermore, the county border effect of payday access has become insignificant later in the sample period, the potential reasons for which are discussed.     

The Question of Sustainability for Microfinance Institutions*

Microentrepreneurs have considerable difficulty accessing capital from mainstream financial institutions. One key reason is that the costs of information about the characteristics and risk levels of borrowers are high. Relationship‐based financing has been promoted as a potential solution to information asymmetry problems in the distribution of credit to small businesses. In this paper, we seek to better understand the implications for providers of “microfinance” in pursuing such a strategy. We discuss relationship‐based financing as practiced by microfinance institutions (MFIs) in the United States, analyze their lending process, and present a model for determining the break‐even price of a microcredit product. Comparing the model’s results with actual prices offered by existing institutions reveals that credit is generally being offered at a range of subsidized rates to microentrepreneurs. This means that MFIs have to raise additional resources from grants or other funds each year to sustain their operations as few are able to survive on the income generated from their lending and related operations. Such subsidization of credit has implications for the long‐term sustainability of institutions serving this market and can help explain why mainstream financial institutions have not directly funded microenterprises. We conclude with a discussion of the role of nonprofit organizations in small business credit markets, the impact of pricing on their potential sustainability and self‐sufficiency, and the implications for strategies to better structure the credit market for microbusinesses.     

Dividend‐Rollover Effect and the Ad Hoc Black‐Scholes Model

One of the most widely used option‐valuation models among practitioners is the ad hoc Black‐Scholes (AHBS) model. The main contribution of this study is methodological. We carefully consider three dividend strategies (No dividend, Implied‐forward dividend, and Actual dividend) for the AHBS model to investigate their effect on pricing errors. We suggest a new dividend strategy, implied‐forward dividend, which incorporates expectational information on dividends embedded in option prices. We demonstrate that our implied‐forward dividend strategy produces more consistent estimates between in‐sample market and model option prices. More importantly our new implied‐forward dividend strategy makes more accurate out‐of‐sample forecasts for one‐day or one‐week ahead prices. Second, we document that both a “Return‐volatility” Smile and a “Return‐pricing Error” Smile exist. From these return characteristics, we make two conclusions: (1) the return dependency of implied volatility is an important explanatory variable and should be controlled to reduce the pricing error of an AHBS model, and (2) it is important for the hedging horizon to be based on return size, that is, the larger the contemporaneous return, the more frequent an option issuer must rebalance the option's hedge. © 2012 Wiley Periodicals, Inc. Jrl Fut Mark 32:742‐772, 2012     

The valuation of inflation‐indexed and FX convertible bonds

This paper derives a valuation model of inflation‐indexed convertible bonds that incorporates the firm's stock price, inflation indexing and the firm's credit risk. The pricing of inflation‐indexed convertible bonds traded on the Tel‐Aviv Stock Exchange (TASE) was empirically tested by using a comprehensive database. The study is the first to empirically test the pricing of convertibles in emerging markets. It was found that the theoretical values for the bonds are, on average, 1.94% higher than the observed market prices. Unlike previous studies, it was found that the underpricing increases with the moneyness of the convertible. It was found that as the maturity lengthens, the underpricing increases. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:634–655, 2008     

Rehabilitation or Liquidation: Consumers' Choices in Bankruptcy

The purpose of this analysis is to identify the legal, environmental, and economic characteristics of debtors that are predictive of their Bankruptcy Code choices. The probability that debtors file under the rehabilitation procedure provided by the Bankruptcy Code (Chapter 13) is influenced by the availability of credit counseling as an alternative to bankruptcy and by the adverse effects of a liquidation bankruptcy (Chapter 7) on future ability to qualify for consumer and mortgage credit. More generous state laws protecting debtors' assets from liquidation in Chapter 7 have a negative effect on the probability that a debtor will contract to repay some debts out of future income in Chapter 13. The results also suggest that the enactment of the Bankruptcy Amendments and Federal Judgeship Act of 1984, which restricted Chapter 13 plans providing zero repayment of unsecured debts, precipitated a decline in the probability that nonbusiness debtors would choose the rehabilitation alternative.     

The promise and peril of dynamic targeted pricing

Dynamic pricing is widely adopted in many industries, such as travel and insurance. These industries are also gaining extensive capabilities in identifying and segmenting customers, partly fueled by the increasing availability of data. It is natural to ask whether firms should take advantage of such developments by charging different prices to different customer segments. If so, under what conditions? We seek answers to these highly managerially relevant questions.We consider a market with two customer segments served by a monopolist. The monopolist can choose among a set of pricing strategies to exploit consumers’ inter-temporal preferences and/or inter-segment variations. At one end of the spectrum, the firm can charge a constant price to all customers, which is called static pricing. At the other end of the spectrum, the firm can charge different prices to different customer segments and vary these prices over time, which is referred to as dynamic targeted pricing. We systematically compare these alternative pricing strategies. We show that dynamic pricing without targeting can be more effective than static targeted pricing when customers are not very forward looking, which corroborates the findings in the empirical literature. Interestingly, we find that the monopolist can be worse off when she adopts targeting in addition to dynamic pricing. We conduct laboratory experiments to test several key model predictions. The studies show that individuals behave in a manner consistent with the predictions of our model.     

NUMERAIRE,SAVINGS AND THE INSTABILITY OF A COMPETITIVE EQUILIBRIUM

This paper addresses the stability of a multimarket competitive equilibrium. The dependence of stability on the choice of the numeraire is clarified. The traditional tâtonnement pricing is revised in order to satisfy some basic features of economic behaviour. Well‐known conditions for local stability are proved to be insufficient if a market for credit is introduced alongside the markets of dated commodities. Stability depends not only on the slopes of the demand and supply curves, but also on equilibrium prices. This result emerges without the occurrence of capital perversities, such as reswitching and reverse capital deepening.     

由生存经济看农村高利贷的表达与实践

本来是一个纯经济现象的高利贷问题,在文化与政治因素介入后,变成了一个复杂的意识形态问题.文化和政治对高利贷的"表达",深刻地影响了高利贷发展的"实践".明清以来的经验显示,高利贷本是一种生存借贷,置农村生存经济状态于不顾的单方面打击高利贷活动,不仅不能根除高利贷产生的土壤,反而加剧了高利贷的风险溢价,降低了小农的信贷可得性,恶化了小农的信贷状况.实际上,小农在借贷活动中,关心的主要是信贷可得性和利息额问题,而不是通常认为的利息率问题.对高利贷问题的不适当"表达",不利于农村融资问题的解决.让农民走出生存经济状况,才能根除高利贷产生的土壤.在仍处于发展中的小农经济状态时,不应将小农的生产借贷也推向生存借贷市场,加大农户的借贷成本,使得正常的生产性投资也难以进行,政策重点在于扶持农村的生产性借贷,千方百计地扩大小农的信贷可得性,并充分利用传统民间金融手段,而不是一味打击所谓的"高利贷".     

发薪日贷款:特点、争论和启示

发薪日贷款在美国大行其道，其简单便利性使穷人也能够获得信贷服务；但是另一方面，由于借款人缺乏自控，不得不连续借贷，从而陷入债务危机，这也导致了政府监管的不断升级。经济学家对发薪日贷款是否改善借款人的福利进行了实证研究，找到了正反两方面的证据。发薪日贷款使我们认识到方便易得的信贷服务的两面性，对我国正在进行农村金融改革有重要的启示。