Extended Loan Terms and Auto Loan Default Risk

Xudong An, Lawrence R. Cordell and Sharon Tang

No 20-18, Working Papers from Federal Reserve Bank of Philadelphia

Abstract: A salient feature of the $1.2 trillion auto-loan market is the extension of loan maturity terms in recent years. Using a large, national sample of auto loans from the entire auto market, we find that the default rates on six- and seven-year loans are multiple times that of shorter five-year term loans. Most of the default risk difference is due to borrower risks associated with longer-term loans, as those longer-term auto borrowers are more credit and liquidity constrained. We also find borrowers’ loan-term choice to be endogenous and that the endogeneity bias is substantial in conventional default model estimates. To mitigate this risk, we separately estimate instrumental variable regression and simultaneous equation models. Finally, we find evidence of adverse selection in borrowers’ loan-term choices in the years when six- and seven-year loans first became widely used, which dissipates over time as lenders adjust to risks in the market.

Keywords: credit risks; adverse selection; auto loans (search for similar items in EconPapers)
JEL-codes: D14 D81 D82 G32 (search for similar items in EconPapers)
Pages: 46
Date: 2020-05-20
New Economics Papers: this item is included in nep-ore and nep-rmg
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Persistent link: https://EconPapers.repec.org/RePEc:fip:fedpwp:88024

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DOI: 10.21799/frbp.wp.2020.18

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