A Simple Dynamic Theory of Credit Scores Under Adverse Selection

Andy Glover and P. Dean Corbae

No 1265, 2015 Meeting Papers from Society for Economic Dynamics

Abstract: We study a dynamic model of unsecured credit markets with adverse selection and an endogenous signal of a borrower's riskiness (modeled as a credit score). Credit contracts are statically constrained efficient in our environment, which is achieved by limiting the debt of low-risk borrowers while subsidizing the interest rate for the high-risk borrowers. A higher credit score (i.e. higher prior that the borrower is low risk) relaxes the constraint on low-risk borrowers and increases the subsidization for high-risk, which means that utility for both types increases with their credit scores. We calibrate the model to salient features of the unsecured credit market and consider the welfare consequences of different information regimes.

Date: 2015
New Economics Papers: this item is included in nep-ban, nep-cta, nep-dge, nep-mic and nep-upt
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:red:sed015:1265

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