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A Theory of Credit Scoring and the Competitive Pricing of Default Risk

Author

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  • Satyajit Chatterjee

    (Federal Reserve Bank of Philadelphia)

  • Dean Corbae

    (University of Wisconsin)

  • Jose-Victor Rios-Rull

    (University of Pennsylvania)

  • Kyle Dempsey

    (The Ohio State University)

Abstract

We propose a theory of unsecured consumer credit where: (i) borrowers have the legal option to default; (ii) defaulters are not exogenously excluded from future borrowing; and (iii) there is free entry of lenders; and (iv) lenders cannot collude to punish defaulters. In our framework, limited credit or credit at higher interest rates following default arises from the lender's optimal response to limited information about the agent's type. The lender learns from an individual's borrowing and repayment behavior about his type and encapsulates his reputation for not defaulting in a credit score. We take the theory to data choosing the parameters of the model to match key data moments such as the overall delinquency rate. We use the model to quantify the value to having a good reputation in the credit market in a variety of ways, and also analyze the differential effects of static versus dynamic costs on credit market equilibria.

Suggested Citation

  • Satyajit Chatterjee & Dean Corbae & Jose-Victor Rios-Rull & Kyle Dempsey, 2018. "A Theory of Credit Scoring and the Competitive Pricing of Default Risk," 2018 Meeting Papers 550, Society for Economic Dynamics.
    • Handle: RePEc:red:sed018:550
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    References listed on IDEAS

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