Loans, Insurance and Failures in the Credit Market for Students

29 Pages Posted: 15 Apr 2011

See all articles by Elena Del Rey

Elena Del Rey

University of Girona

Bertrand Verheyden

affiliation not provided to SSRN

Date Written: April 13, 2011

Abstract

In the education literature, it is generally acknowledged that both credit and insurance for students are rationed. In order to provide a rationale for these observations, we present a model with perfectly competitive banks and risk averse students who have private information on their ability to learn and can decide to default on debt. We show that the combination of ex-post moral hazard and adverse selection produces credit market rationing when default penalties are low. When default penalties increase, the level of student risk aversion proves crucial in determining the market outcome. If risk aversion is low, banks offer non-insuring pooling contracts at equilibrium that may result in overinvestment in education. If student risk aversion is high, high ability students are separated and student loan contracts involve a limited amount of insurance.

Keywords: ex-post moral hazard, adverse selection, income contingent loans

JEL Classification: D820, I220

Suggested Citation

Del Rey, Elena and Verheyden, Bertrand, Loans, Insurance and Failures in the Credit Market for Students (April 13, 2011). CESifo Working Paper Series No. 3410, Available at SSRN: https://ssrn.com/abstract=1808639 or http://dx.doi.org/10.2139/ssrn.1808639

Elena Del Rey (Contact Author)

University of Girona ( email )

Girona, 17071
Spain

Bertrand Verheyden

affiliation not provided to SSRN ( email )

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