A Quantitative Theory of the Credit Score

70 Pages Posted: 2 Oct 2020

See all articles by Satyajit Chatterjee

Satyajit Chatterjee

Federal Reserve Bank of Philadelphia

Dean Corbae

University of Wisconsin - Madison

Kyle Dempsey

Ohio State University

Jose-Victor Rios-Rull

University of Minnesota - Twin Cities

Multiple version iconThere are 2 versions of this paper

Date Written: September 1, 2020

Abstract

What is the role of credit scores in credit markets? We argue that it is a stand-in for a market assessment of a person’s unobservable type (which here we take to be patience). We pose a model of persistent hidden types where observable actions shape the public assessment of a person’s type via Bayesian updating. We show how dynamic reputation can incentivize repayment without monetary costs of default beyond the administrative cost of filing for bankruptcy. Importantly, we show how an economy with credit scores implements the same equilibrium allocation. We estimate the model using both credit market data and the evolution of individuals’ credit scores. We find a 3% difference in patience in almost equally sized groups in the population with significant turnover and a shift towards becoming more patient with age. If tracking of individual credit actions is outlawed, the benefits of bankruptcy forgiveness are outweighed by the higher interest rates associated with lower incentives to repay.

Keywords: Credit Scores, Unsecured Consumer Credit, Bankruptcy, Persistent Private Information.

JEL Classification: D82, E21, G51

Suggested Citation

Chatterjee, Satyajit and Corbae, Dean and Dempsey, Kyle and Rios-Rull, Jose-Victor, A Quantitative Theory of the Credit Score (September 1, 2020). FRB of Philadelphia Working Paper No. 20-39, Available at SSRN: https://ssrn.com/abstract=3702350 or http://dx.doi.org/10.21799/frbp.wp.2020.39

Satyajit Chatterjee (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

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Dean Corbae

University of Wisconsin - Madison ( email )

716 Langdon Street
Madison, WI 53706-1481
United States

Kyle Dempsey

Ohio State University ( email )

United States

Jose-Victor Rios-Rull

University of Minnesota - Twin Cities ( email )

420 Delaware St. SE
Minneapolis, MN 55455
United States

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