Measuring Aversion to Debt: An Experiment Among Student Loan Candidates∗

This paper reports the results of an experiment designed to test for the presence of debt aversion. The population who participated in the experiment were recent financial aid candidates and the experiment focused on student loans. The goal is to shed new light on different aspects of the perceptions with respect to debt. These perceptions can prevent agents from choosing an optimal portfolio or from undertaking attractive investment opportunities, such as in education. Our design disentangles two types of debt aversion: the one that is studied in the previous literature, which encompasses both framing and labeling effects, and another that controls for framing effects and identifies only what we denote labeling debt aversion. The results suggest that participants in the experiment exhibit debt aversion, and most of the debt aversion is due to labeling effects. Labeling a contract as a “loan” decreases its probability of being chosen over a financially equivalent contract by more than 8%. We also provide evidence that students are willing to pay a premium of about 4% of the financed value to avoid a contract labeled as debt. ∗We thank Juan David Herreño for valuable research assistance, the World Bank for providing funding for this project, and Lumni Inc. for conducting the surveys. We are grateful to seminar participants at the Australian National University, the University of Naples Federico II, the Darden School (University of Virginia), the University of Leicester and the World Bank for valuable suggestions and comments. †Economics Department, University of Rochester. Email: [email protected]. 238 Harkness Hall, P.O. Box 270156, NY 14627 (USA). http://web.me.com/gregorio.caetano/Caetano/Home.html ‡Owen Graduate School of Management, Vanderbilt University. Email: [email protected]. Phone: +1(615)322-8059. Address: 401 21st Avenue South, Nashville, TN 37212 (USA). http://owen.vanderbilt.edu/palacios. Co-founder and shareholder of Lumni Inc. §Lead Education Economist, The World Bank.