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Liquidity Constraints and Their Causes: Evidence from Subprime Lending

Author

Listed:
  • Liran Einav

    (Stanford University)

  • Jonathan Levin

    (Stanford University)

  • William Adams

    (Citigroup)

Abstract

We present new evidence on consumer liquidity constraints and the credit market conditions that might give rise to them. Our analysis is based on unique data from a large auto sales and financing company that serves the subprime market. We first document the role of short-term liquidity in driving purchasing behavior, including sharp increases in demand during tax rebate season and a high sensitivity to minimum down payment requirements. We then explore the informational problems facing subprime lenders. We find that default rates rise significantly with loan size, providing a rationale for lenders to impose loan caps because of moral hazard. We also find that borrowers at the highest risk of default demand the largest loans, but the degree of adverse selection is largely mitigated by effective risk-based pricing. Finally, we show that state interest rate caps may play a role in tightening liquidity constraints.

Suggested Citation

  • Liran Einav & Jonathan Levin & William Adams, 2007. "Liquidity Constraints and Their Causes: Evidence from Subprime Lending," 2007 Meeting Papers 52, Society for Economic Dynamics.
    • Handle: RePEc:red:sed007:52
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    References listed on IDEAS

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    Cited by:

    1. Chi, Li-Chiu, 2009. "How have banks fared following a borrower's financial distress?," Economic Modelling, Elsevier, vol. 26(2), pages 480-488, March.
    2. Tseng-Chung Tang, 2008. "The costs of lead bank--distressed borrower relationships: evidence from commercial lending in Taiwan," The Service Industries Journal, Taylor & Francis Journals, vol. 30(9), pages 1549-1563, September.

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