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Costly Contracts and Consumer Credit

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  • Livshits, Igor
  • MacGee, James
  • Tertilt, Michèle

Abstract

Financial innovations are a common explanation of the rise in consumer credit and bankruptcies. To evaluate this story, we develop a simple model that incorporates two key frictions: asymmetric information about borrowers’ risk of default and a fixed cost to create each contract offered by lenders. Innovations which reduce the fixed cost or ameliorate asymmetric information have large extensive margin effects via the entry of new lending contracts targeted at riskier borrowers. This results in more defaults and borrowing, as well as increased dispersion of interest rates. Using the Survey of Consumer Finance and interest rate data collected by the Board of Governors, we find evidence supporting these predictions, as the dispersion of credit card interest rates nearly tripled, and the share of credit card debt of lower income households nearly doubled.

Suggested Citation

  • Livshits, Igor & MacGee, James & Tertilt, Michèle, 2011. "Costly Contracts and Consumer Credit," CEPR Discussion Papers 8580, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:8580
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    References listed on IDEAS

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    Cited by:

    1. Jason Allen & Robert Clark & Jean-François Houde, 2014. "Price Dispersion in Mortgage Markets," Journal of Industrial Economics, Wiley Blackwell, vol. 62(3), pages 377-416, September.
    2. Lukasz A. Drozd & Ricardo Serrano-Padial, 2013. "Modeling the credit card revolution: the role of debt collection and informal bankruptcy," Working Papers 13-12, Federal Reserve Bank of Philadelphia.
    3. Daniel, Sanches, 2011. "A dynamic model of unsecured credit," Journal of Economic Theory, Elsevier, vol. 146(5), pages 1941-1964, September.
    4. Bulent Guler, 2015. "Innovations in Information Technology and the Mortgage Market," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 18(3), pages 456-483, July.
    5. Igor Livshits, 2015. "Recent Developments In Consumer Credit And Default Literature," Journal of Economic Surveys, Wiley Blackwell, vol. 29(4), pages 594-613, September.
    6. Guiso, Luigi & Sodini, Paolo, 2013. "Household Finance: An Emerging Field," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1397-1532, Elsevier.
    7. Jason Allen & H. Evren Damar & David Martinez-Miera, 2016. "Consumer Bankruptcy, Bank Mergers, and Information," Review of Finance, European Finance Association, vol. 20(4), pages 1289-1320.
    8. Silvia Magri, 2018. "Are lenders using risk-based pricing in the consumer loan market? The effects of the 2008 crisis," Temi di discussione (Economic working papers) 1164, Bank of Italy, Economic Research and International Relations Area.
    9. Athreya, Kartik & Tam, Xuan S. & Young, Eric R., 2009. "Unsecured credit markets are not insurance markets," Journal of Monetary Economics, Elsevier, vol. 56(1), pages 83-103, January.
    10. Borghan Nezami Narajabad, 2012. "Information Technology and the Rise of Household Bankruptcy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(4), pages 526-550, October.
    11. Hülya Eraslan & Gizem Koşar & Wenli Li & Pierre‐Daniel Sarte, 2017. "An Anatomy Of U.S. Personal Bankruptcy Under Chapter 13," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 58(3), pages 671-702, August.
    12. Kartik B. Athreya & Xuan S. Tam & Eric R. Young, 2009. "Are harsh penalties for default really better?," Working Paper 09-11, Federal Reserve Bank of Richmond.
    13. N. Narajabad, Borghan, 2010. "Information Technology and the Rise of Household Bankruptcy," MPRA Paper 21058, University Library of Munich, Germany.
    14. Luzzetti, Matthew N. & Neumuller, Seth, 2016. "Learning and the dynamics of consumer unsecured debt and bankruptcies," Journal of Economic Dynamics and Control, Elsevier, vol. 67(C), pages 22-39.
    15. Athreya, Kartik B., 2014. "Big Ideas in Macroeconomics: A Nontechnical View," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262019736, December.
    16. Robert McKeown, 2017. "How Vulnerable Is The Canadian Banking System To Fire-sales?," Working Paper 1381, Economics Department, Queen's University.

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    More about this item

    Keywords

    bankruptcy; consumer credit; endogenous financial contracts;
    All these keywords.

    JEL classification:

    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E49 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Other
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • K35 - Law and Economics - - Other Substantive Areas of Law - - - Personal Bankruptcy Law

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