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Predatory lending in rational world

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  • Philip Bond
  • David K. Musto
  • Bilge Yilmaz
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    Abstract

    Regulators express growing concern over “predatory lending,” which we take to mean lending that reduces the expected utility of borrowers. We present a rational model of consumer credit in which such lending is possible, and identify the circumstances in which it arises with and without competition. Predatory lending is associated with imperfect competition, highly collateralized loans, and poorly informed borrowers. Under most circumstances competition among lenders eliminates predatory lending.

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    File URL: http://www.philadelphiafed.org/research-and-data/publications/working-papers//2006/wp06-2.pdf
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    Bibliographic Info

    Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 06-2.

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    Date of creation: 2006
    Date of revision:
    Handle: RePEc:fip:fedpwp:06-2

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    Keywords: Predatory lending;

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    1. Mark Flannery & Katherine Samolyk, 2005. "Payday lending: do the costs justify the price?," Proceedings 949, Federal Reserve Bank of Chicago.
    2. Kathleen C. Engel & Patricia A. McCoy, 2001. "The law and economics of remedies of predatory lending," Proceedings 790, Federal Reserve Bank of Chicago.
    3. Richard Hynes & Eric A. Posner, 2002. "The Law and Economics of Consumer Finance," American Law and Economics Review, Oxford University Press, vol. 4(1), pages 168-207, January.
    4. Manove, Michael & Padilla, Atilano Jorge, 1998. "Banking (Conservatively) With Optimists," CEPR Discussion Papers 1918, C.E.P.R. Discussion Papers.
    5. Wilde, Louis L. & Schwartz, Alan., . "Equilibrium Comparison Shopping," Working Papers 184, California Institute of Technology, Division of the Humanities and Social Sciences.
    6. Salop, Steven & Stiglitz, Joseph E, 1977. "Bargains and Ripoffs: A Model of Monopolistically Competitive Price Dispersion," Review of Economic Studies, Wiley Blackwell, vol. 44(3), pages 493-510, October.
    7. Laibson, David I. & Gabaix, Xavier, 2006. "Shrouded Attributes, Consumer Myopia, and Information Suppression in Competitive Markets," Scholarly Articles 4554333, Harvard University Department of Economics.
    8. Ausubel, Lawrence M, 1991. "The Failure of Competition in the Credit Card Market," American Economic Review, American Economic Association, vol. 81(1), pages 50-81, March.
    9. Rock, Kevin, 1986. "Why new issues are underpriced," Journal of Financial Economics, Elsevier, vol. 15(1-2), pages 187-212.
    10. Varian, Hal R, 1980. "A Model of Sales," American Economic Review, American Economic Association, vol. 70(4), pages 651-59, September.
    11. Beales, Howard & Craswell, Richard & Salop, Steven C, 1981. "The Efficient Regulation of Consumer Information," Journal of Law and Economics, University of Chicago Press, vol. 24(3), pages 491-539, December.
    12. Malmendier, Ulrike M. & Della Vigna, Stefano, 2003. "Contract Design and Self Control: Theory and Evidence," Research Papers 1801, Stanford University, Graduate School of Business.
    13. Manove, Michael & Padilla, A Jorge & Pagano, Marco, 2001. "Collateral versus Project Screening: A Model of Lazy Banks," RAND Journal of Economics, The RAND Corporation, vol. 32(4), pages 726-44, Winter.
    14. George J. Stigler, 1961. "The Economics of Information," Journal of Political Economy, University of Chicago Press, vol. 69, pages 213.
    15. Schwartz, Alan & Wilde, Louis L, 1982. "Imperfect Information, Monopolistic Competition, and Public Policy," American Economic Review, American Economic Association, vol. 72(2), pages 18-23, May.
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    Cited by:
    1. Danny Ben-Shahar, 2008. "Default, Credit Scoring, and Loan-to-Value: a Theoretical Analysis under Competitive and Non-Competitive Mortgage Markets," Journal of Real Estate Research, American Real Estate Society, vol. 30(2), pages 161-190.
    2. Elul, Ronel, 2008. "Collateral, credit history, and the financial decelerator," Journal of Financial Intermediation, Elsevier, vol. 17(1), pages 63-88, January.

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