Exploiting Naïvete about Self-Control in the Credit Market

Due to the nonredundancy condition, the competitive-equilibrium contracts we derive exclude most options by assumption; in particular, nonsophisticated borrowers’ only option to change the repayment schedule will be to change it by a lot for a large fee. As is usually the case in models of nonlinear pricing, the same outcomes can also be implemented by allowing other choices, but making them so expensive that the borrower does not want to choose them. In fact, this is how it works in the real-life examples discussed below, where deferring even small amounts of repayment carries disproportionately large fees....