Working Paper: CEPR ID: DP8580
Authors: Igor Livshits; James MacGee; Michle Tertilt
Abstract: 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.
Keywords: bankruptcy; consumer credit; endogenous financial contracts
JEL Codes: E21; E49; G18; K35
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| reduced fixed costs (D24) | increase in the variety of credit products (G21) |
| increase in the variety of credit products (G21) | higher borrowing levels (H74) |
| higher borrowing levels (H74) | increase in defaults (G33) |
| improved risk assessment (D80) | more accurate pricing of loans (G21) |
| improved risk assessment (D80) | reduced misclassification of high-risk borrowers as low-risk (G21) |
| improved risk assessment (D80) | increase in access to credit for riskier borrowers (G21) |
| increase in access to credit for riskier borrowers (G21) | higher overall borrowing (H74) |
| higher overall borrowing (H74) | increase in defaults (G33) |
| decreased costs of funds (G21) | increased borrowing (H74) |
| increased borrowing (H74) | increase in defaults (G33) |