Costly Contracts and Consumer Credit

45 Pages Posted: 29 Sep 2011

See all articles by Igor Livshits

Igor Livshits

Federal Reserve Bank of Philadelphia; University of Western Ontario - Department of Economics

James MacGee

University of Western Ontario - Department of Economics

Michèle Tertilt

University of Mannheim - Department of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: September 2011

Abstract

Financial innovations are a common explanation of the rise in consumer credit and bankruptcies. To evaluate this story, we develop a simple model that incorporates two key frictions: asymmetric information about borrowers’ risk of default and a fixed cost to create each contract offered by lenders. Innovations which reduce the fixed cost or ameliorate asymmetric information have large extensive margin effects via the entry of new lending contracts targeted at riskier borrowers. This results in more defaults and borrowing, as well as increased dispersion of interest rates. Using the Survey of Consumer Finance and interest rate data collected by the Board of Governors, we find evidence supporting these predictions, as the dispersion of credit card interest rates nearly tripled, and the share of credit card debt of lower income households nearly doubled.

Keywords: bankruptcy, consumer credit, endogenous financial contracts

JEL Classification: E21, E49, G18, K35

Suggested Citation

Livshits, Igor and MacGee, James and Tertilt, Michèle, Costly Contracts and Consumer Credit (September 2011). CEPR Discussion Paper No. DP8580. Available at SSRN: https://ssrn.com/abstract=1935256

Igor Livshits (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
United States

University of Western Ontario - Department of Economics ( email )

London, Ontario N6A 5B8
Canada

James MacGee

University of Western Ontario - Department of Economics ( email )

London, Ontario N6A 5B8
Canada

Michèle Tertilt

University of Mannheim - Department of Economics ( email )

D-68131 Mannheim
Germany

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