Costly Screening, Self-Selection, Fraud, and the Organization of Credit Markets

Anthony Yezer and Pingkang Yu ()

Working Papers from The George Washington University, Institute for International Economic Policy

Abstract: This paper analyzes a credit market that includes a costly, universal and imperfect screening technology with both type I and type II errors and borrower self-selection. Universal screening is necessary because there are fraudulent borrowers. These characteristics, which have been omitted from other models, make it more representative of actual mortgage and consumer lending conditions. Contrary to the results in previous models with random screening, the combination of universal screening and type I screening error produces a pooling equilibrium as a non-trivial outcome. This result suggests that generalized lenders can sometimes compete with specialized lenders serving a single borrower type in credit markets that rely on costly lender screening. At other times pooling lenders will not be competitive and this, by itself, could lead to periodic waves of failure. These theoretical results appear to have implications for stability in markets for consumer credit.

Keywords: costly screening; screening cost; self selection; pooling equilibrium; separating equilibrium (search for similar items in EconPapers)
JEL-codes: D82 D86 G20 L16 (search for similar items in EconPapers)
Pages: 30 pages
Date: 2016-05
New Economics Papers: this item is included in nep-cta
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Persistent link: https://EconPapers.repec.org/RePEc:gwi:wpaper:2016-4

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