Price-Driven Adverse Selection in Consumer Lending

This paper shows how price-driven adverse selection in consumer lending can be explained in terms of differential price-sensitivity between lenders who will default (“bads”) and those who will not (“goods”). We show that price-driven adverse selection will characterize any market in which “goods” are more price-elastic than “bads”. In such a situation, it is possible that there are some segments to whom it is unprofitable to lend at any price. This provides an explanation of the common practice of credit rationing in commercial credit markets.

[1]  Hayriye Ayhan,et al.  Relationships Among Three Assumptions in Revenue Management , 2004, Oper. Res..

[2]  Martha Poon,et al.  Scorecards as Devices for Consumer Credit: The Case of Fair, Isaac & Company Incorporated , 2007 .

[3]  R. Zeckhauser,et al.  Adverse Selection and Adverse Retention , 1998 .

[4]  Dean S. Karlan,et al.  Observing Unobservables: Identifying Information Asymmetries with a Consumer Credit Field Experiment , 2005 .

[5]  M. W. Green,et al.  2. Handbook of the Logistic Distribution , 1991 .

[6]  Gerard J. van den Berg,et al.  On the Uniqueness of Optimal Prices Set by Monopolistic Sellers , 2007 .

[7]  Martin A. Lariviere,et al.  A Note on Probability Distributions with Increasing Generalized Failure Rates , 2006, Oper. Res..

[8]  Aldo Rustichini,et al.  Cognitive skills affect economic preferences, strategic behavior, and job attachment , 2009, Proceedings of the National Academy of Sciences.

[9]  George A. Akerlof.  The Market for “Lemons”: Quality Uncertainty and the Market Mechanism , 1970 .

[10]  J. Beshears,et al.  Who Selected Adjustable-Rate Mortgages? Evidence from the 1989-2007 Surveys of Consumer Finances , 2009 .

[11]  Lawrence M. Ausubel.  Adverse Selection in the Credit Card Market , 1999 .

[12]  Wendy Edelberg.  Testing for Adverse Selection and Moral Hazard in Consumer Loan Markets , 2004 .

[13]  J. Stiglitz,et al.  Credit Rationing in Markets with Imperfect Information , 1981 .

[14]  Arnaud de Servigny,et al.  Measuring and Managing Credit Risk , 2004 .

[15]  Stochastic Orders , 2008 .

[16]  L. Thomas.  Consumer credit models , 2009 .

[17]  Marvin Zelen,et al.  Mathematical Theory of Reliability , 1965 .

[18]  David Genesove,et al.  Adverse Selection in the Wholesale Used Car Market , 1993, Journal of Political Economy.

[19]  Evan L. Porteus,et al.  Selling to the Newsvendor: An Analysis of Price-Only Contracts , 2001, Manuf. Serv. Oper. Manag..

[20]  Bernd Engelmann,et al.  The Basel II risk parameters : estimation, validation, and stress testing , 2006 .

[21]  Bradley S. Wimmer,et al.  Adverse Selection, Seller Effort, and Selection Bias , 2006 .

[22]  L. Thomas.  Consumer credit models: pricing, profit and portfolios , 2009 .

[23]  Wendy Edelberg,et al.  Risk-based pricing of interest rates for consumer loans , 2006 .

[24]  R. Phillips,et al.  Pricing and Revenue Optimization , 2005 .