Given the low welfare of nonsophisticated borrowers in the unrestricted market, we turn to identifying welfare-improving interventions. Because in a restricted market borrowers have the option of paying a small fee for deferring a small amount of repayment, nonsophisticated but nottoo- naïve borrowers do not drastically mispredict their future behavior, and hence have higher utility than in the unrestricted market. Since sophisticated borrowers achieve the highest possible utility in both markets, this means that a restricted market often Pareto dominates the unrestricted one. If many borrowers are very naïve, a restricted market can be combined with an interest-rate cap to try to limit borrowers’ misprediction and achieve.
