Asymmetric Information and the Automobile Loan Market

Abstract

Information revelation can occur in a variety of ways. For example, in the home mortgage market, borrowers reveal their expected house tenure through their choice of mortgage contracts. As a result, lenders offer a menu of mortgage interest rate and point combinations in an effort to learn private information about borrowers' potential mobility. This paper uses a unique dataset of individual automobile loan performance to assess whether borrower consumption choice reveals information about future loan performance. Results indicate that the automotive make and model a consumer selects provides information about the loan's performance - that is, we observe differential loan performance after we control for borrower characteristics. The results from this study suggest that lenders, instead of charging a house-rate for all auto loans, could profitably pursue risk-based pricing based on the type of car the borrower purchases.

Keywords: Consumer debt, consumption decisions, prepayment, default

JEL Classification: G2, C41, D14, D82