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The Emergence of Captive Finance Companies and Risk Segmentation of the Consumer Loan Market:Theory and Evidence

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  • Michael E. Staten
  • John M. Barron
  • Andrew B. Chong

Abstract

A parental seller with market power to some degree in its product market can earn rents. In this context, there is a gain to granting credit for the purchase of the product and thus the establishment of captive finance company for expanding the sales by offering loans to consumers who need financing for purchase of durable good. This paper examines the optimal behavior of such a durable good seller and its captive finance company when the consumer loan market is segmented into captive and independent lending institutions under symmetric and imperfect information on borrower’s creditworthiness. The model presents that one critical difference for captive finance company will be its credit standard. Specifically, the model indicates that captive finance company will follow a more lenient credit standard, leading to the prediction that the likelihood of repayment of a captive loan is lower than that of a bank loan, other things equal. This prediction is tested using unique data sets drawn from a major credit bureau in the U.S. The analysis of credit bureau data shows that a captive automobile loan is less likely to be repaid than a bank automobile loan, which supports the theoretical prediction.

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 Far Eastern Meetings with number 584.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:feam04:584

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Keywords: Monopolistic Competition; Consumer Loan Market; Captive Finance Company; Differential Loan Performances;

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  1. Valev, N, 1996. "International Lending by US Banks," Papers 96-010, Purdue University, Krannert School of Management - Center for International Business Education and Research (CIBER).
  2. David B. Gross & Nicholas S. Souleles, 2001. "An Empirical Analysis of Personal Bankruptcy and Delinquency," NBER Working Papers 8409, National Bureau of Economic Research, Inc.
  3. Staten, Michael E & Gilley, Otis W & Umbeck, John, 1990. "Information Costs and the Organization of Credit Markets: A Theory of Indirect Lending," Economic Inquiry, Western Economic Association International, vol. 28(3), pages 508-29, July.
  4. Hogan, W P, 1999. "The Future of Banking: A Survey," The Economic Record, The Economic Society of Australia, vol. 75(231), pages 417-27, December.
  5. Xavier Freixas & Jean-Charles Rochet, 1997. "Microeconomics of Banking," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262061937, December.
  6. Mark Carey & Mitch Post & Steven A. Sharpe, 1998. "Does Corporate Lending by Banks and Finance Companies Differ? Evidence on Specialization in Private Debt Contracting," Journal of Finance, American Finance Association, vol. 53(3), pages 845-878, 06.
  7. Brueckner, Jan K, 2000. "Mortgage Default with Asymmetric Information," The Journal of Real Estate Finance and Economics, Springer, vol. 20(3), pages 251-74, May.
  8. Boczar, Gregory E, 1978. "Competition between Banks and Finance Companies: A Cross Section Study of Personal Loan Debtors," Journal of Finance, American Finance Association, vol. 33(1), pages 245-58, March.
  9. Eli M. Remolona & Kurt C. Wulfekuhler, 1992. "Finance companies, bank competition, and niche markets," Quarterly Review, Federal Reserve Bank of New York, issue Sum, pages 25-38.
  10. John M. Barron & Michael E. Staten & Stephanie M. Wilshusen, 2002. "The Impact Of Casino Gambling On Personal Bankruptcy Filing Rates," Contemporary Economic Policy, Western Economic Association International, vol. 20(4), pages 440-455, October.
  11. Perloff, Jeffrey M & Salop, Steven, 1984. "Equilibrium with product differentiation," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series qt4cq0m6s3, Department of Agricultural & Resource Economics, UC Berkeley.
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Cited by:
  1. Alena Bicakova, 2007. "Does the Good Matter? Evidence on Moral Hazard and Adverse Selection from Consumer Credit Market," Economics Working Papers ECO2007/02, European University Institute.

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