A Finite-Life Private-Information Theory of Unsecured Consumer Debt

51 Pages Posted: 25 Jun 2007

See all articles by Satyajit Chatterjee

Satyajit Chatterjee

Federal Reserve Bank of Philadelphia

Philip Dean Corbae

University of Wisconsin - Madison - Department of Finance, Investment and Banking

José-Victor Rios-Rull

University of Pennsylvania - Department of Economics; NBER Research Associate

Date Written: May 28, 2007

Abstract

The authors present a theory of unsecured consumer debt that does not rely on utility costs of default or on enforcement mechanisms that arise in repeated-interaction settings. The theory is based on private information about a person's type and on a person's incentive to signal his type to entities other than creditors. Specifically, debtors signal their low-risk status to insurers by avoiding default in credit markets. The signal is credible because in equilibrium people who repay are more likely to be the low-risk type and so receive better insurance terms. The authors explore two different mechanisms through which repayment behavior in the credit market can be positively correlated with low-risk status in the insurance market. Their theory is motivated in part by some facts regarding the role of credit scores in consumer credit and auto insurance markets.

Keywords: Unsecured Consumer Debt, Bankruptcy, Default, Adverse Selection, Credit Score, Insurance

JEL Classification: D82, D91, G19

Suggested Citation

Chatterjee, Satyajit and Corbae, Philip Dean and Rios-Rull, José-Victor, A Finite-Life Private-Information Theory of Unsecured Consumer Debt (May 28, 2007). FRB of Philadelphia Working Paper No. 07-14, Available at SSRN: https://ssrn.com/abstract=991315 or http://dx.doi.org/10.2139/ssrn.991315

Satyajit Chatterjee (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

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Philip Dean Corbae

University of Wisconsin - Madison - Department of Finance, Investment and Banking ( email )

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José-Victor Rios-Rull

University of Pennsylvania - Department of Economics ( email )

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United States
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215-573-2057 (Fax)

NBER Research Associate

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