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A Portfolio View of Consumer Credit

  • David K. Musto
  • Nicholas S. Souleles

To compute risk-adjusted returns and gauge the volatility of their portfolios, lenders need to know the covariances of their loans' returns with aggregate returns. Cross-sectional differences in these covariances also provide insight into the nature of the shocks hitting different types of consumers. We 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. We 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.

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File URL: http://www.nber.org/papers/w11735.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 11735.

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Date of creation: Nov 2005
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Publication status: published as Musto, David K. and Nicholas S. Souleles. "A Portfolio View Of Consumer Credit," Journal of Monetary Economics, 2006, v53(1,Jan), 59-84.
Handle: RePEc:nbr:nberwo:11735
Note: AP EFG ME
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  1. David B. Gross & Nicholas S. Souleles, 2002. "Do Liquidity Constraints And Interest Rates Matter For Consumer Behavior? Evidence From Credit Card Data," The Quarterly Journal of Economics, MIT Press, vol. 117(1), pages 149-185, February.
  2. David B. Gross, 2002. "An Empirical Analysis of Personal Bankruptcy and Delinquency," Review of Financial Studies, Society for Financial Studies, vol. 15(1), pages 319-347, March.
  3. 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, vol. 36(1), pages 39-72, February.
  4. Fama, Eugene F & MacBeth, James D, 1973. "Risk, Return, and Equilibrium: Empirical Tests," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 607-36, May-June.
  5. Souphala Chomsisengphet & Ronel Elul, 2005. "Bankruptcy exemptions, credit history, and the mortgage market," Working Papers 04-14, Federal Reserve Bank of Philadelphia.
  6. Irina Barakova & Raphael Bostic & Paul Calem & Susan Wachter, 2003. "Does Credit Quality Matter for Homeownership?," Working Paper 8608, USC Lusk Center for Real Estate.
  7. David K. Musto, 2004. "What Happens When Information Leaves a Market? Evidence from Postbankruptcy Consumers," The Journal of Business, University of Chicago Press, vol. 77(4), pages 725-748, October.
  8. Anthony Pennington-Cross & Joseph Nichols, 2000. "Credit History and the FHA-Conventional Choice," Real Estate Economics, American Real Estate and Urban Economics Association, vol. 28(2), pages 307-336.
  9. Hanson, Samuel G. & Pesaran, M. Hashem & Schuermann, Til, 2008. "Firm heterogeneity and credit risk diversification," Journal of Empirical Finance, Elsevier, vol. 15(4), pages 583-612, September.
  10. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
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