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"CREDIT MARKETS"
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Judging Borrowers by the Company They Keep: Friendship Networks and Information Asymmetry in Online Peer-to-Peer Lending
We study the online market for peer-to-peer (P2P) lending, in which individuals bid on unsecured microloans sought by other individual borrowers. Using a large sample of consummated and failed listings from the largest online P2P lending marketplace, Prosper.com, we find that the online friendships of borrowers act as signals of credit quality. Friendships increase the probability of successful funding, lower interest rates on funded loans, and are associated with lower ex post default rates. The economic effects of friendships show a striking gradation based on the roles and identities of the friends. We discuss the implications of our findings for the disintermediation of financial markets and the design of decentralized electronic markets.
This paper was accepted by Sandra Slaughter, information systems.
Journal Article
Observing Unobservables: Identifying Information Asymmetries With a Consumer Credit Field Experiment
Information asymmetries are important in theory but difficult to identify in practice. We estimate the presence and importance of hidden information and hidden action problems in a consumer credit market using a new field experiment methodology. We randomized 58,000 direct mail offers to former clients of a major South African lender along three dimensions: (i) an initial \"offer interest rate\" featured on a direct mail solicitation; (ii) a \"contract interest rate\" that was revealed only after a borrower agreed to the initial offer rate; and (ii) a dynamic repayment incentive that was also a surprise and extended preferential pricing on future loans to borrowers who remained in good standing. These three randomizations, combined with complete knowledge of the lender's information set, permit identification of specific types of private information problems. Our setup distinguishes hidden information effects from selection on the offer rate (via unobservable risk and anticipated effort), from hidden action effects (via moral hazard in effort) induced by actual contract terms. We find strong evidence of moral hazard and weaker evidence of hidden information problems. A rough estimate suggests that perhaps 13% to 21% of default is due to moral hazard. Asymmetric information thus may help explain the prevalence of credit constraints even in a market that specializes in financing high-risk borrowers.
Journal Article
CONTRACT PRICING IN CONSUMER CREDIT MARKETS
We analyze subprime consumer lending and the role played by down payment requirements in screening high-risk borrowers and limiting defaults. To do this, we develop an empirical model of the demand for financed purchases that incorporates both adverse selection and repayment incentives. We estimate the model using detailed transaction-level data on subprime auto loans. We show how different elements of loan contracts affect the quality of the borrower pool and subsequent loan performance. We also evaluate the returns to credit scoring that allows sellers to customize financing terms to individual applicants. Our approach shows how standard econometric tools for analyzing demand and supply under imperfect competition extend to settings in which firms care about the identity of their customers and their postpurchase behavior.
Journal Article
To Build or to Buy? The Role of Local Information in Credit Market Development
Exploiting the heterogeneity in legal constraints on local bank employees’ mobility, I show that access to local information influences banks’ modes of expansion. As restrictions on interbank labor mobility are relaxed, banks entering a new market establish branches directly instead of acquiring incumbent branches, resulting in a shift of composition of entrants. The treatment effect is strengthened when information asymmetries between local banks and entrants are severe. Furthermore, I find a surge in the volume and a reduction in the rates of local small business loans originated by surrounding incumbent banks after the entry of outside banks, especially after entrants establish new branches.
This paper was accepted by Lauren Cohen, finance.
Journal Article
Credit Market Imperfections and the Distribution of Policy Rents
This article shows that credit market imperfections have important implications for the distribution of policy rents. In a model with land as fixed factor and credit market imperfections, when an area payment is given, land rents go up by more than the subsidy. On aggregate farms may lose from the subsidy. The results depend on the extent to which subsidies have direct and indirect effects on the credit constraints, on whether farms rent or own land, and on farm heterogeneity.
Journal Article
Reading the Fine Print: Information Disclosure in the Brazilian Credit Card Market
Consumer credit regulations usually require that lenders disclose interest rates. However, in the absence of specific prominence requirements, lenders can conceal the interest rate in the fine print while still complying with the law. I examine the effect of such a strategy using a field experiment in Brazil in which a credit card company offered their clients payment plans to pay off their balances. Using randomized contract interest rates and the degree of rate disclosure, I show that most clients are rate sensitive, whether or not rates are prominently disclosed. The elasticity of payment plan enrollment with respect to the interest rate ranges from −0.711 to −0.880. High-risk clients are an exception; these clients are rate sensitive only when disclosure is prominent. I also show that clients are influenced by nudges that favor longer-term contracts. Conditional on enrollment, the proportion of clients who choose a longer-term contract is 40 percentage points higher when a longer-term contract is featured in the advertisement layout. This effect, however, is weaker when stakes are higher.
Data, as supplemental material, are available at
http://dx.doi.org/10.1287/mnsc.2015.2281
.
This paper was accepted by Wei Jiang, finance.
Journal Article
Payday Loans and Credit Cards: New Liquidity and Credit Scoring Puzzles?
This paper identifies and discusses possible liquidity and credit scoring puzzles. Regarding liquidity, it is found that most account holders with a major credit card issuer have substantial unused liquidity on there credit cards at the time they borrow on payday loans. Their annual pecuniary losses from payday borrowing, compared to using their credit cards, are large compared to previously identified liquid debt puzzles. Regarding credit scores, payday lenders could obtain useful information about default probabilities by examining the FICO scores of applicants in addition to Teletrack scores, and credit card issuers would benefit from having frequently updated information about whether their account holders are payday borrowers. The authors conjecture that small costs could at least begin to explain these phenomena. Credit bureaus charge lenders small fees for each score query, and those fees might exceed the value of the marginal creditworthiness information obtained. On the consumer side, Zinman, Borzekowski, and Kiser discuss models of account-specific characteristics that can incorporate the realist variety of pecuniary, nonpecuniary, and cognitive costs.
Journal Article
What Do Consumers Really Pay on Their Checking and Credit Card Accounts? Explicit, Implicit, and Avoidable Costs
This paper presents several new stylized facts on what people actually pay to use their checking and credit card accounts. The median household pays $500 per year and could avoid more than half these costs with minor changes in behavior. Translating these avoidable costs into consumption terms, most consumers could afford to borrow more than 1,000 additional dollars simply by allocating payment choices more efficiently. Penalty fees are economically important (representing about half of total fees, and the lion's share of checking account costs), and most penalty fees are easily avoidable by the paper's metrics. Interest and avoidable interest generally persist over time; in contrast, fee and avoidable fee costs are negatively correlated over time for many consumers. Tremendous heterogeneity is found on all margins of costs and cost persistence.
Journal Article
Courts and Banks: Effects of Judicial Enforcement on Credit Markets
The cost of enforcing contracts is a key determinant of market performance. We document this point with reference to the credit market in a model of opportunistic debtors and inefficient courts. According to the model, improvements in judicial efficiency should reduce credit constraints and increase lending, with an ambiguous effect on interest rates that depends on banking competition and on the type of judicial reform. These predictions are supported by panel data on Italian provinces. In provinces with longer trials or large backlogs of pending trials, credit is less widely available.
Journal Article