Regulating Consumer Credit with Over-Optimistic Borrowers

Florian Exler, Igor Livshits, James (Jim) MacGee () and Michele Tertilt

No 1064, 2018 Meeting Papers from Society for Economic Dynamics

Abstract: We quantitatively analyze consumer credit markets with behavioral consumers and default. Our model incorporates over-optimistic and rational borrower types into a standard incomplete markets with consumer bankruptcy framework. Lenders price credit endogenously, forming beliefs - type scores - about borrowers' types. Since over-optimistic borrowers incorrectly believe they have rational beliefs, lenders do not need to take strategic behavior into account when updating type scores. We find that the partial pooling of over-optimistic with rational borrowers results in spill-overs across types via interest rates, with over-optimists being cross-subsidized by rational consumers who have lower default rates. Higher interest rates lower the average debt level of realists compared to a world without over-optimists. Due to overestimating their ability to repay, over-optimists borrow too much. We evaluate three policies to address these frictions: reducing the cost of default, educating over-optimists about their true type, and increasing borrowing cost. Of the three, only the lower default costs improve the welfare of over-optimists. However, rational consumers are made worse off by that policy.

Date: 2018
New Economics Papers: this item is included in nep-dge
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://red-files-public.s3.amazonaws.com/meetpapers/2018/paper_1064.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:red:sed018:1064

Access Statistics for this paper

More papers in 2018 Meeting Papers from Society for Economic Dynamics Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA. Contact information at EDIRC.
Bibliographic data for series maintained by Christian Zimmermann ().