Loans, Insurance and Failures in the Credit Market for Students
AbstractWhereas public student loans are often income contingent, private banks typically offer pure loans, or don't offer loans at all. In order to provide a rationale for these observations, we present a model with perfectly competitive banks and risk averse students who have private information on their ability to learn. We show that the combination of ex-post moral hazard and adverse selection produces credit market rationing when default penalties are low. Intermediate levels of default penalties can result in the existence of an equilibrium that pools together ability types. However, pooling contracts are not insuring at equilibrium, which implies a second type of credit market failure. Finally, if default penalties are large enough, equilibrium contracts provide less able students with insurance against the eventuality of a bad outcome, just in the income contingent loan fashion. The model is also used to explain other stylized facts, such as the positive impact of returns to education and interest rate subsidies on the development of the student loan market. Also, it explains why, unlike banks, governments oer income contingent loans.
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Bibliographic InfoPaper provided by Barcelona Graduate School of Economics in its series Working Papers with number 359.
Date of creation: Aug 2008
Date of revision:
ex-post moral hazard; adverse selection; income contingent loans;
Other versions of this item:
- Elena Del Rey & Bertrand Verheyden, 2011. "Loans, Insurance and Failures in the Credit Market for Students," CESifo Working Paper Series 3410, CESifo Group Munich.
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- I22 - Health, Education, and Welfare - - Education - - - Educational Finance
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