The Endowment Effect and Demand for Collateralized Loans

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Date and Time: 
Monday, April 16, 2018
2:00 pm – 3:30 pm
Gautam Rao
Harvard University

This project tests a novel theoretical mechanism for low take-up of credit. If borrowers suffer from the endowment effect (Kahneman et al., 1990), then risky loans collateralized with existing assets may trigger loss aversion, and be particularly unattractive to borrowers. In contrast, loans collateralized with the new asset to be purchased using the loan itself – as in car loans in rich countries – may be relatively attractive, since borrowers may dislike losing future assets less. We provide evidence for such an effect using a randomized experiment with dairy farmers in Kenya. In addition, we examine whether preferring loans collateralized with new assets is a "mistake" resulting from borrowers systematically underestimating their future attachment to the new asset.