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A Simple Dynamic Theory of Credit Scores Under Adverse Selection

Author

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  • Andrew Glover

    (University of Texas at Austin)

  • Dean Corbae

    (University of Wisconsin)

Abstract

We study a dynamic model of unsecured credit markets with adverse selection and an endogenous signal of a borrower's riskiness (modeled as a credit score). Credit contracts are statically constrained efficient in our environment, which is achieved by limiting the debt of low-risk borrowers while subsidizing the interest rate for the high-risk borrowers. A higher credit score (i.e. higher prior that the borrower is low risk) relaxes the constraint on low-risk borrowers and increases the subsidization for high-risk, which means that utility for both types increases with their credit scores. We calibrate the model to salient features of the unsecured credit market and consider the welfare consequences of different information regimes.

Suggested Citation

  • Andrew Glover & Dean Corbae, 2015. "A Simple Dynamic Theory of Credit Scores Under Adverse Selection," 2015 Meeting Papers 1265, Society for Economic Dynamics.
  • Handle: RePEc:red:sed015:1265
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    File URL: https://economicdynamics.org/meetpapers/2015/paper_1265.pdf
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    References listed on IDEAS

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    1. Kartik Athreya & Xuan S. Tam & Eric R. Young, 2012. "A Quantitative Theory of Information and Unsecured Credit," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(3), pages 153-183, July.
    2. Nick Netzer & Florian Scheuer, 2014. "A Game Theoretic Foundation Of Competitive Equilibria With Adverse Selection," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 55, pages 399-422, May.
    3. Chatterjee, Satyajit & Corbae, Dean & Ríos-Rull, José-Víctor, 2008. "A finite-life private-information theory of unsecured consumer debt," Journal of Economic Theory, Elsevier, vol. 142(1), pages 149-177, September.
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    Cited by:

    1. Kyle Herkenhoff, 2016. "The Impact of Consumer Credit Access on Employment, Earnings and Entrepreneurship," 2016 Meeting Papers 781, Society for Economic Dynamics.

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