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Liquidity Constraints and Their Causes: Evidence from Subprime Lending

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  • 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.

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Paper provided by Society for Economic Dynamics in its series 2007 Meeting Papers with number 52.

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Date of creation: 2007
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Handle: RePEc:red:sed007:52

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  1. Jappelli, Tullio, 1990. "Who Is Credit Constrained in the U.S. Economy?," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 219-34, February.
  2. Pierre-André Chiappori & Bernard Salanié, 1997. "Testing for Asymmetric Information in Insurance Markets," Working Papers 97-11, Centre de Recherche en Economie et Statistique.
  3. Jaffee, Dwight M & Russell, Thomas, 1976. "Imperfect Information, Uncertainty, and Credit Rationing," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 651-66, November.
  4. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June.
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