Discounting and Defaulting: Evidence from Time Preference Experiments and Administrative Credit Data

debt-clipart-aTeK6aRqcThis paper was presented by Stephan Meier and Charles Sprenger at the Family Financial Security Symposium in April, 2010.  If defaulting is a decision in which consumers weigh the present benefits of not having to repay their debts against the future costs of potentially being excluded from financial markets or stigmatized, individual time preferences should be a key determinant of defaulting.  This paper links experimentally measured differences in time preferences to objectively measured differences in defaulting behavior.

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Prior empirical analyses of credit default demonstrate the importance of policy-driven differences in costs and benefits. However, little is known about individual determinants of default within a given institutional setting.

Theoretically the defaulting decision is intertemporal in nature: present benefits of default are weighed against discounted delayed costs.  Meier and Sprenger empirically tested the relationship between discounting and defaulting by matching experimentally elicited time preference measures to credit reports and tax data.  Within a common institutional setting and controlling for socio-demographics, debt levels, buffers against income shocks, and credit constraints, the results show substantial correlation between discounting and defaulting.