Building Credit History with Heterogeneously Informed Lenders

Natalia Kovrijnykh (), Igor Livshits and Ariel Zetlin-Jones

No 19-17, Working Papers from Federal Reserve Bank of Philadelphia

Abstract: This paper examines a novel mechanism of credit-history building as a way of aggregating information across multiple lenders. We build a dynamic model with multiple competing lenders, who have heterogeneous private information about a consumer's creditworthiness, and extend credit over multiple stages. Acquiring a loan at an early stage serves as a positive signal | it allows the borrower to convey to other lenders the existence of a positively informed lender (advancing that early loan) | thereby convincing other lenders to extend further credit in future stages. This signaling may be costly to the least risky borrowers for two reasons. First, taking on an early loan may involve cross-subsidization from the least risky borrowers to more risky borrowers. Second, the least risky borrowers may take inefficiently large loans relative to the symmetric-information benchmark. We demonstrate that, despite these two possible costs, the least risky borrowers often prefer these equilibria to those without information aggregation. Our analysis offers an interesting and novel insight into debt dilution. Contrary to the conventional wisdom, repayment of the early loan is more likely when a borrower subsequently takes on a larger rather than a smaller additional loan. This result hinges on a selection effect: larger subsequent loans are only given to the least risky borrowers.

Keywords: Credit History; Information Aggregation; Debt Dilution (search for similar items in EconPapers)
JEL-codes: D14 D82 D83 D86 G21 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2019-03-13
New Economics Papers: this item is included in nep-ban and nep-mic
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Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedpwp:19-17

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DOI: 10.21799/frbp.wp.2019.18

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