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The Student Loan Consolidation Option: An Analysis of an Exotic Financial Derivative: Working Paper 2007-05

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  • Deborah Lucas
  • Damien Moore

Abstract

The federal government makes subsidized federal financing for higher education widely available. The extent of the subsidy varies over time with interest rate and credit market conditions. A loan provision that adds considerably to the size and volatility of the subsidy is the consolidation option, which allows students to convert floating-rate federal loans to a fixed rate equal to the average floating rate on their outstanding loans. We develop a model to estimate the option’s cost and to evaluate its sensitivity to changes in program rules, economic conditions, and borrower behavior. We model borrower behavior using data from the National Student Loan Data System, which provides new insights on the responsiveness of consumers to financial incentives.

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File URL: http://www.cbo.gov/sites/default/files/cbofiles/ftpdocs/79xx/doc7981/2007-05.pdf
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Bibliographic Info

Paper provided by Congressional Budget Office in its series Working Papers with number 18540.

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Date of creation: 01 Apr 2007
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Handle: RePEc:cbo:wpaper:18540

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  1. Susan Dynarski, 2002. "The Behavioral and Distributional Implications of Aid for College," American Economic Review, American Economic Association, vol. 92(2), pages 279-285, May.
  2. Lucas, Deborah & McDonald, Robert L., 2006. "An options-based approach to evaluating the risk of Fannie Mae and Freddie Mac," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 155-176, January.
  3. Michael P. Keane, 2002. "Financial Aid, Borrowing Constraints, and College Attendance: Evidence from Structural Estimates," American Economic Review, American Economic Association, vol. 92(2), pages 293-297, May.
  4. David B. Gross & Nicholas S. Souleles, 2002. "Do Liquidity Constraints And Interest Rates Matter For Consumer Behavior? Evidence From Credit Card Data," The Quarterly Journal of Economics, MIT Press, vol. 117(1), pages 149-185, February.
  5. Jagannathan, Ravi & Kaplin, Andrew & Sun, Steve, 2003. "An evaluation of multi-factor CIR models using LIBOR, swap rates, and cap and swaption prices," Journal of Econometrics, Elsevier, vol. 116(1-2), pages 113-146.
  6. William G. Gale, 1988. "Economic Effects of Federal Credit Programs," UCLA Economics Working Papers 483, UCLA Department of Economics.
  7. Aaron S. Edlin, 1993. "Is College Financial Aid Equitable and Efficient?," Journal of Economic Perspectives, American Economic Association, vol. 7(2), pages 143-158, Spring.
  8. Hanushek, Eric A, 1989. "Expenditures, Efficiency, and Equity in Education: The Federal Government's Role," American Economic Review, American Economic Association, vol. 79(2), pages 46-51, May.
  9. G. S. Maddala, 1987. "Limited Dependent Variable Models Using Panel Data," Journal of Human Resources, University of Wisconsin Press, vol. 22(3), pages 307-338.
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