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

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

Journal of Economic Theory, 2008, vol. 142, issue 1, 149-177

Abstract: We 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. We explore two different mechanisms through which repayment behavior in the credit market can be positively correlated with low-risk status in the insurance market. Our theory is motivated in part by some facts regarding the role of credit scores in consumer credit and auto insurance markets.

Date: 2008
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jetheo:v:142:y:2008:i:1:p:149-177

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