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Costly Contracts and Consumer Credit

  • Igor Livshits
  • James MacGee
  • Michèle Tertilt

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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 17448.

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Date of creation: Sep 2011
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Handle: RePEc:nbr:nberwo:17448
Note: EFG
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  1. Allen N. Berger & W. Scott Frame & Nathan H. Miller, 2002. "Credit scoring and the availability, price, and risk of small business credit," Finance and Economics Discussion Series 2002-26, Board of Governors of the Federal Reserve System (U.S.).
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  3. Kartik Athreya, 2001. "The growth of unsecured credit : are we better off?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 11-33.
  4. Kartik Athreya, 2008. "A Quantitative Theory of Information and Unsecured Credit," 2008 Meeting Papers 68, Society for Economic Dynamics.
  5. Veronica Guerrieri & Robert Shimer & Randall Wright, 2010. "Adverse Selection in Competitive Search Equilibrium," Econometrica, Econometric Society, vol. 78(6), pages 1823-1862, November.
  6. Igor Livshits & James MacGee & Michele Tertilt, 2005. "Consumer Bankruptcy: A Fresh Start," Discussion Papers 04-011, Stanford Institute for Economic Policy Research.
  7. Juan M. Sánchez, 2010. "The IT revolution and the unsecured credit market," Working Papers 2010-022, Federal Reserve Bank of St. Louis.
  8. William Adams & Liran Einav & Jonathan Levin, 2007. "Liquidity Constraints and Imperfect Information in Subprime Lending," NBER Working Papers 13067, National Bureau of Economic Research, Inc.
  9. N. Narajabad, Borghan, 2010. "Information Technology and the Rise of Household Bankruptcy," MPRA Paper 21058, University Library of Munich, Germany.
  10. Margaret J. Miller (ed.), 2003. "Credit Reporting Systems and the International Economy," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262134225, June.
  11. 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.
  12. Jaffee, Dwight M & Russell, Thomas, 1984. "Imperfect Information, Uncertainty, and Credit Rationing: A Reply," The Quarterly Journal of Economics, MIT Press, vol. 99(4), pages 869-72, November.
  13. Jaromir B. Nosal & Lukasz A. Drozd, 2008. "Competing for Customers: A Search Model of the Market for Unsecured Credit," 2008 Meeting Papers 274, Society for Economic Dynamics.
  14. Satyajit Chatterjee & Dean Corbae & Jose-Victor Rios-Rull, 2006. "Finite-Life, Private-Information Theory of Unsecured Debt," 2006 Meeting Papers 781, Society for Economic Dynamics.
  15. Arthur B. Kennickell & Martha Starr-McCluer & Brian J. Surette, 2000. "Recent changes in U. S. family finances: results from the 1998 Survey of Consumer Finances," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jan, pages 1-29.
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