Working Paper: NBER ID: w17448
Authors: Igor Livshits; James MacGee; Michèle 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: financial innovations; consumer credit; bankruptcies; asymmetric information
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 |
|---|---|
| Financial innovations (G29) | More credit contracts offered (G21) |
| More credit contracts offered (G21) | Access to risky loans for higher-risk borrowers (G21) |
| Access to risky loans for higher-risk borrowers (G21) | Aggregate borrowing increases (F65) |
| Access to risky loans for higher-risk borrowers (G21) | Higher default rates (E43) |
| Improved risk assessment technologies reduce misclassification of borrowers (G21) | Improved risk-based pricing (G19) |
| Improved risk-based pricing (G19) | Interest rates charged (E43) |