Credit Scoring and Endogenous Stigma

Michele Tertilt, Jim MacGee and Igor Livshits
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Jim MacGee: University of Western Ontario

No 544, 2007 Meeting Papers from Society for Economic Dynamics

Abstract: Consumer bankruptcy has increased more than 4-fold since 1980. Livshits, MacGee, and Tertilt (2006) show that a decline in the social stigma of bankruptcy together with a decline in the transactions cost of borrowing can account for both increased filings and increased unsecured borrowing by consumers. In this paper, we argue that technological advances in credit scoring technologies can generate a reduction in the cost of lending and lead to an endogenous decline in the stigma of filing for bankruptcy. The story is that improvements in credit scoring technology have allowed lenders to better differentiate between borrowers with different default risks. However, this in turn has led to a reduction in the information about a consumers default risk (type) revealed by filing for bankruptcy. As a result, the penalty in terms of higher future interest rates and tighter borrowing constraints associated with being a bankrupt has fallen over time. This endogenous decline in the information cost of bankruptcy leads to an increase in equilibrium bankruptcy filings. At the same time, overall borrowing may go up because loans for some types are cheaper, as their default risk is priced more accurately.

Date: 2007
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed007:544

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