A finite-life private-information theory of unsecured consumer debt

Satyajit Chatterjee (), P. Dean Corbae () and José-Víctor Ríos-Rull ()

No 07-14, Working Papers from Federal Reserve Bank of Philadelphia

Abstract: The authors present a theory of unsecured consumer debt that does not rely on utility costs of default or on enforcement mechanisms that arise in repeated-interaction settings. The theory is based on private information about a person's type and on a person's incentive to signal his type to entities other than creditors. Specifically, debtors signal their low-risk status to insurers by avoiding default in credit markets. The signal is credible because in equilibrium people who repay are more likely to be the low-risk type and so receive better insurance terms. The authors explore two different mechanisms through which repayment behavior in the credit market can be positively correlated with low-risk status in the insurance market. Their theory is motivated in part by some facts regarding the role of credit scores in consumer credit and auto insurance markets.

Date: 2007

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Journal Article: A finite-life private-information theory of unsecured consumer debt (2008)
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