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Does the Good Matter? Evidence on Moral Hazard and Adverse Selection from Consumer Credit Market

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  • Alena Bicakova

Abstract

Default rates on instalment loans vary with type of the good purchased. Using an Italian dataset of instalment loans between 1995-1999, we first show that the variation persists even after controlling for contract and individual-specific characteristics, and for the potential selection bias due to credit rationing. We explore whether the residual variation in the default rates across the different types of goods is due to unobserved individual heterogeneity (selection effect) or due to the effect of the specific characteristics of the good (good effect). We claim that the two effects may be interpreted as adverse selection and moral hazard. We exploit the data on multiple contracts per individual to disentangle the two effects, and find that most of the variation is explained by the selection effect. Individuals who buy motorcycles on credit are more likely to default on any loan, while those buying kitchen appliances, furniture and computers are more likely to repay, compared to average. We conclude that there is asymmetric information in the consumer credit market, mostly in the form of adverse selection.

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Bibliographic Info

Paper provided by European University Institute in its series Economics Working Papers with number ECO2007/02.

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Date of creation: 2007
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Handle: RePEc:eui:euiwps:eco2007/02

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Keywords: consumer credit; default; adverse selection; moral hazard;

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References

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  1. Elisabetta Iossa & Giuliana Palumbo, 2004. "Product quality, lender liability, and consumer credit," Oxford Economic Papers, Oxford University Press, vol. 56(2), pages 331-343, April.
  2. Orazio Attanasio & Pinelopi K. Goldberg & Ekaterini Kyriazidou, 2000. "Credit Constraints in the Market for Consumer Durables: Evidence from Micro Data on Car Loans," NBER Working Papers 7694, National Bureau of Economic Research, Inc.
  3. Bertola, Giuseppe & Hochguertel, Stefan & Koeniger, Winfried, 2002. "Dealer Pricing of Consumer Credit," IZA Discussion Papers 440, Institute for the Study of Labor (IZA).
  4. Michael E. Staten & John M. Barron & Andrew B. Chong, 2004. "The Emergence of Captive Finance Companies and Risk Segmentation of the Consumer Loan Market:Theory and Evidence," Econometric Society 2004 Far Eastern Meetings 584, Econometric Society.
  5. Wang, H.J. & White, M., 1998. "An Optimal Personal Bankruptcy Procedure and Proposed Reform," Papers 98-07, Michigan - Center for Research on Economic & Social Theory.
  6. Luca Casolaro & Leonardo Gambacorta & Luigi Guiso, 2005. "Regulation, formal and informal enforcement and the development of the household loan market. Lessons from Italy," Temi di discussione (Economic working papers) 560, Bank of Italy, Economic Research and International Relations Area.
  7. Rob Alessie & Stefan Hochguertel & Guglielmo Weber, 2005. "Consumer Credit: Evidence From Italian Micro Data," Journal of the European Economic Association, MIT Press, vol. 3(1), pages 144-178, 03.
  8. Charles Grant & Mario Padula, 2006. "Informal Credit Markets, Judicial Costs and Consumer Credit: Evidence from Firm Level Data," CSEF Working Papers 155, Centre for Studies in Economics and Finance (CSEF), University of Naples, Italy.
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Cited by:
  1. Grant, Charles & Padula, Mario, 2013. "Using bounds to investigate household debt repayment behaviour," Research in Economics, Elsevier, vol. 67(4), pages 336-354.
  2. Mario Padula & Charles Grant, 2007. "Bounds on repayment behavior: evidence for the consumer credit market," Working Papers 2007_26, Department of Economics, University of Venice "Ca' Foscari".

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