Rationality in the Consumer Credit Market : Choosing between Alternative and Mainstream Credit

In this paper we study whether consumers optimally choose between formal and informal credit, using a unique panel dataset with all registered information available on consumers' behavior within the Swedish alternative and mainstream credit markets. Specifically, we analyze to what extent credit applications and existing credit lines at any mainstream financial institution influence the decision to take pawn credit. We find the likelihood of applying for pawn credit, on average, increases by 8.8 percent for those whose loan application was rejected by the regular bank. However, we also find that the lion's share of pawn credit borrowers do not apply for mainstream (cheaper) credit before taking a pawn loan. The decision not to apply, however, turns out to be rational -- we find that 93 percent of their loan applications would have been rejected had they applied for credit at a mainstream financial institution. Finally, we find evidence suggesting that immigrant pawn credit borrowers, are at least, equally well-informed about their chances to obtain mainstream regular credit as their Swedish born counterparts