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Loans, Insurance and Failures in the Credit Market for Students

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  • Elena Del Rey
  • Bertrand Verheyden

Abstract

In the education literature, it is generally acknowledged that both credit and insurance for students are rationed. 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 and can decide to default on debt. We show that the combination of ex-post moral hazard and adverse selection produces credit market rationing when default penalties are low. When default penalties increase, the level of student risk aversion proves crucial in determining the market outcome. If risk aversion is low, banks offer non-insuring pooling contracts at equilibrium that may result in overinvestment in education. If student risk aversion is high, high ability students are separated and student loan contracts involve a limited amount of insurance.

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File URL: http://www.cesifo-group.de/portal/page/portal/DocBase_Content/WP/WP-CESifo_Working_Papers/wp-cesifo-2011/wp-cesifo-2011-04/cesifo1_wp3410.pdf
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Bibliographic Info

Paper provided by CESifo Group Munich in its series CESifo Working Paper Series with number 3410.

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Date of creation: 2011
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Handle: RePEc:ces:ceswps:_3410

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Keywords: ex-post moral hazard; adverse selection; income contingent loans;

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  1. Bruce Chapman, 2005. "Income Contingent Loans for Higher Education: International Reform," CEPR Discussion Papers 491, Centre for Economic Policy Research, Research School of Economics, Australian National University.
  2. David Croix & Philippe Michel, 2007. "Education and growth with endogenous debt constraints," Economic Theory, Springer, vol. 33(3), pages 509-530, December.
  3. Lance Lochner & Alexander Monge-Naranjo, 2010. "The Nature of Credit Constraints and Human Capital," Working Papers 2011-024, Human Capital and Economic Opportunity Working Group.
  4. Timothy J Kehoe & David K Levine, 1993. "Debt Constrained Asset Markets," Levine's Working Paper Archive 1276, David K. Levine.
  5. Chen, Hung-ju, 2005. "Educational systems, growth and income distribution: a quantitative study," Journal of Development Economics, Elsevier, vol. 76(2), pages 325-353, April.
  6. Bruce Chapman & David Greenaway, 2006. "Learning to Live with Loans? International Policy Transfer and the Funding of Higher Education," The World Economy, Wiley Blackwell, vol. 29(8), pages 1057-1075, 08.
  7. de Meza, David & Webb, David C, 1987. "Too Much Investment: A Problem of Asymmetric Information," The Quarterly Journal of Economics, MIT Press, vol. 102(2), pages 281-92, May.
  8. Canton, Erik & Blom, Andreas, 2004. "Can student loans improve accessibility to higher education and student performance? An impact study of the case of SOFES, Mexico," Policy Research Working Paper Series 3425, The World Bank.
  9. Bas Jacobs & Sweder J.G. van Wijnbergen, 2005. "Capital Market Failure, Adverse Selection and Equity Financing of Higher Education," Tinbergen Institute Discussion Papers 05-037/3, Tinbergen Institute.
  10. Zeira, Joseph, 1991. "Credit Rationing in an Open Economy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 32(4), pages 959-72, November.
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