Building Credit History with Heterogeneously Informed Lenders

45 Pages Posted: 14 Mar 2019 Last revised: 29 Apr 2020

See all articles by Natalia Kovrijnykh

Natalia Kovrijnykh

Arizona State University (ASU) - Economics Department

Igor Livshits

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

Ariel Zetlin-Jones

Carnegie Mellon University; Federal Reserve Bank of Minneapolis

Date Written: 2019-03-13

Abstract

This paper examines a novel mechanism of credit-history building as a way of aggregating information across multiple lenders. We build a dynamic model with multiple competing lenders, who have heterogeneous private information about a consumer's creditworthiness, and extend credit over multiple stages. Acquiring a loan at an early stage serves as a positive signal | it allows the borrower to convey to other lenders the existence of a positively informed lender (advancing that early loan) | thereby convincing other lenders to extend further credit in future stages. This signaling may be costly to the least risky borrowers for two reasons. First, taking on an early loan may involve cross-subsidization from the least risky borrowers to more risky borrowers. Second, the least risky borrowers may take inefficiently large loans relative to the symmetric-information benchmark. We demonstrate that, despite these two possible costs, the least risky borrowers often prefer these equilibria to those without information aggregation. Our analysis offers an interesting and novel insight into debt dilution. Contrary to the conventional wisdom, repayment of the early loan is more likely when a borrower subsequently takes on a larger rather than a smaller additional loan. This result hinges on a selection effect: larger subsequent loans are only given to the least risky borrowers.

Keywords: Credit History, Information Aggregation, Debt Dilution

JEL Classification: D14, D82, D83, D86, G21

Suggested Citation

Kovrijnykh, Natalia and Livshits, Igor and Zetlin-Jones, Ariel, Building Credit History with Heterogeneously Informed Lenders (2019-03-13). FRB of Philadelphia Working Paper No. 19-17, Available at SSRN: https://ssrn.com/abstract=3352602 or http://dx.doi.org/10.21799/frbp.wp.2019.18

Natalia Kovrijnykh

Arizona State University (ASU) - Economics Department ( email )

Tempe, AZ 85287-3806
United States

HOME PAGE: http://www.public.asu.edu/~nkovrijn

Igor Livshits

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

Ariel Zetlin-Jones (Contact Author)

Carnegie Mellon University ( email )

Pittsburgh, PA 15213-3890
United States

Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

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