How Costly Is Noise? Data and Disparities in Consumer Credit

Laura Blattner and Scott Nelson
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Laura Blattner: Stanford University
Scott Nelson: Chicago Booth

Research Papers from Stanford University, Graduate School of Business

Abstract: We show that lenders face more uncertainty when assessing default risk of historically under-served groups in US credit markets and that this information disparity is a quantitatively important driver of inefficient and unequal credit market outcomes. We first document that widely used credit scores are statistically noisier indicators of default risk for historically under-served groups. This noise emerges primarily through the explanatory power of the underlying credit report data (e.g., thin credit files), not through issues with model fit (e.g., the inability to include protected class in the scoring model). Estimating a structural model of lending with heterogeneity in information, we quantify the gains from addressing these information disparities for the US mortgage market. We find that equalizing the precision of credit scores can reduce disparities in approval rates and in credit misallocation for disadvantaged groups by approximately half.

Date: 2021-05
New Economics Papers: this item is included in nep-ure
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Persistent link: https://EconPapers.repec.org/RePEc:ecl:stabus:3978

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