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A Quantitative Theory of the Credit Score

Author

Listed:
  • Satyajit Chatterjee
  • Dean Corbae
  • Kyle P. Dempsey
  • José-Víctor Ríos-Rull

Abstract

What is the role of credit scores in credit markets? We argue that it is a stand in for a market assessment of a person’s unobservable type (which here we take to be patience). We pose a model of persistent hidden types where observable actions shape the public assessment of a person’s type via Bayesian updating. We show how dynamic reputation can incentivize repayment without monetary costs of default beyond the administrative cost of filing for bankruptcy. Importantly we show how an economy with credit scores implements the same equilibrium allocation. We estimate the model using both credit market data and the evolution of individual’s credit scores. We find a 3% difference in patience in almost equally sized groups in the population with significant turnover and a shift towards becoming more patient with age. If tracking of individual credit actions is outlawed, the benefits of bankruptcy forgiveness are outweighed by the higher interest rates associated with lower incentives to repay.

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  • Satyajit Chatterjee & Dean Corbae & Kyle P. Dempsey & José-Víctor Ríos-Rull, 2020. "A Quantitative Theory of the Credit Score," NBER Working Papers 27671, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:27671
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    References listed on IDEAS

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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • G51 - Financial Economics - - Household Finance - - - Household Savings, Borrowing, Debt, and Wealth

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