Working Paper: NBER ID: w27671
Authors: Satyajit Chatterjee; Dean Corbae; Kyle P. Dempsey; Josvctor Rosrull
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.
Keywords: credit scores; credit markets; borrower behavior; Bayesian updating; dynamic reputation
JEL Codes: D82; E21; G51
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| credit scores (G51) | market assessment of a person's unobservable type (D80) |
| observable actions (C99) | lenders' perceptions (G21) |
| lenders' perceptions (G21) | credit score (G51) |
| credit score (G51) | future borrowing conditions (F34) |
| decline in credit score (G51) | worse borrowing conditions (F65) |
| prohibition of tracking (Y50) | individual welfare (I30) |
| pooling patient and impatient types (I11) | higher interest rates for young borrowers (G51) |
| dynamic reputation (C69) | incentivize repayment (H81) |