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A portfolio view of consumer credit

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  • David K. Musto
  • Nicholas Souleles

Abstract

This paper takes a portfolio view of consumer credit. Default models (credit-risk scores) estimate the probability of default of individual loans. But to compute risk-adjusted returns, lenders also need to know the covariances of the returns on their loans with aggregate returns. Covariances are independently relevant for lenders who care directly about the volatility of their portfolios, e.g., because of Value-at-Risk considerations or the structure of the securitization market. Cross-sectional differences in these covariances also provide insight into the nature of the shocks hitting different types of consumers. ; The authors use a unique panel dataset of credit bureau records to measure the ‘covariance risk’ of individual consumers, i.e., the covariance of their default risk with aggregate consumer default rates, and more generally to analyze the cross-sectional distribution of credit, including the effects of credit scores. They obtain two key sets of results. First, there is significant systematic heterogeneity in covariance risk across consumers with different characteristics. Consumers with high covariance risk tend to also have low credit scores (high default probabilities). Second, the amount of credit obtained by consumers significantly increases with their credit scores, and significantly decreases with their covariance risk (especially revolving credit), though the effect of covariance risk is smaller in magnitude. It appears that some lenders take covariance risk into account, at least in part, in determining the amount of credit they provide. ; Also issued as Payment Cards Center Discussion Paper No. 05-15

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 05-25.

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Date of creation: 2005
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Handle: RePEc:fip:fedpwp:05-25

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Keywords: Consumer credit ; Credit scoring systems;

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References

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  1. Souleles, Nicholas S, 2004. "Expectations, Heterogeneous Forecast Errors, and Consumption: Micro Evidence from the Michigan Consumer Sentiment Surveys," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 36(1), pages 39-72, February.
  2. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
  3. Irina Barakova & Raphael Bostic & Paul Calem & Susan Wachter, . "Does Credit Quality Matter for Homeownership?," Zell/Lurie Center Working Papers, Wharton School Samuel Zell and Robert Lurie Real Estate Center, University of Pennsylvania 410, Wharton School Samuel Zell and Robert Lurie Real Estate Center, University of Pennsylvania.
  4. David B. Gross, 2002. "An Empirical Analysis of Personal Bankruptcy and Delinquency," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 15(1), pages 319-347, March.
  5. Anthony Pennington-Cross & Joseph Nichols, . "Credit History and the FHA-Conventional Choice," Zell/Lurie Center Working Papers, Wharton School Samuel Zell and Robert Lurie Real Estate Center, University of Pennsylvania 319, Wharton School Samuel Zell and Robert Lurie Real Estate Center, University of Pennsylvania.
  6. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, American Finance Association, vol. 19(3), pages 425-442, 09.
  7. David B. Gross & Nicholas S. Souleles, 2001. "Do Liquidity Constraints and Interest Rates Matter for Consumer Behavior? Evidence from Credit Card Data," NBER Working Papers 8314, National Bureau of Economic Research, Inc.
  8. Souphala Chomsisengphet & Ronel Elul, 2005. "Bankruptcy exemptions, credit history, and the mortgage market," Working Papers, Federal Reserve Bank of Philadelphia 04-14, Federal Reserve Bank of Philadelphia.
  9. Samuel Hanson & M. Hashem Pesaran & Til Schuermann, 2005. "Firm Heterogeneity and Credit Risk Diversification," CESifo Working Paper Series, CESifo Group Munich 1531, CESifo Group Munich.
  10. David K. Musto, 2004. "What Happens When Information Leaves a Market? Evidence from Postbankruptcy Consumers," The Journal of Business, University of Chicago Press, University of Chicago Press, vol. 77(4), pages 725-748, October.
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Cited by:
  1. Chintal Desai & Andre Mollick, 2014. "On Consumer Credit Outcomes in the U.S.-Mexico Border Region," Journal of Financial Services Research, Springer, Springer, vol. 45(1), pages 91-115, February.
  2. Sumit Agarwal & Souphala Chomsisengphet & Chunlin Liu & Nicholas S. Souleles, 2006. "Do consumers choose the right credit contracts?," Working Paper Series, Federal Reserve Bank of Chicago WP-06-11, Federal Reserve Bank of Chicago.
  3. Chintal Desai & Gregory Elliehausen & Edward Lawrence, 2014. "On the County-Level Credit Outcome Beta," Journal of Financial Services Research, Springer, Springer, vol. 45(2), pages 201-218, April.
  4. Kristopher S. Gerardi & Andreas Lehnert & Shane M. Sherlund & Paul S. Willen, 2009. "Making sense of the subprime crisis," Public Policy Discussion Paper, Federal Reserve Bank of Boston 09-1, Federal Reserve Bank of Boston.
  5. Scholnick, Barry, 2009. "Credit card use after the final mortgage payment: does the magnitude of income shocks matter?," Working Paper Series, European Central Bank 1142, European Central Bank.
  6. Gary Gorton & Nicholas Souleles, 2005. "Special Purpose Vehicles and Securitization," NBER Working Papers 11190, National Bureau of Economic Research, Inc.
  7. Sumit Agarwal & Chunlin Liu & Nicholas Souleles, 2007. "The reaction of consumer spending and debt to tax rebates; evidence from consumer credit data," Working Papers, Federal Reserve Bank of Philadelphia 07-34, Federal Reserve Bank of Philadelphia.
  8. Sumit Agarwal & Souphala Chomsisengphet & Chunlin Liu & Nicholas S. Souleles, 2010. "Benefits of relationship banking: evidence from consumer credit markets," Working Paper Series, Federal Reserve Bank of Chicago WP-2010-05, Federal Reserve Bank of Chicago.

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