Credit Cycle and Adverse Selection Effects in Consumer Credit Markets - Evidence from the HELOC Market
Paul S. Calem
Federal Reserve Banks - Federal Reserve Bank of Philadelphia
Leonard I. Nakamura
Federal Reserve Bank of Philadelphia
FRB of Philadelphia Working Paper No. 11-13
The authors empirically study how the underlying riskiness of the pool of home equity line of credit originations is affected over the credit cycle. Drawing from the largest existing database of U.S. home equity lines of credit, they use county-level aggregates of these loans to estimate panel regressions on the characteristics of the borrowers and their loans, and competing risk hazard regressions on the outcomes of the loans. The authors show that when the expected unemployment risk of households increases, riskier households tend to borrow more. As a consequence, the pool of households that borrow on home equity lines of credit worsens along both observable and unobservable dimensions. This is an interesting example of a type of dynamic adverse selection that can worsen the risk characteristics of new lending, and suggests another avenue by which the precautionary demand for liquidity may affect borrowing.
Number of Pages in PDF File: 42
Date posted: March 10, 2011
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