Consumer credit with over-optimistic borrowers / by Florian Exler, Igor Livshits, James MacGee and Michèle Tertilt.: FB3-5/2020-57E-PDF

"There is active debate over whether borrowers' cognitive biases create a need for regulation to limit the misuse of credit. To tackle this question, we incorporate overoptimistic borrowers into an incomplete markets model with consumer bankruptcy. Lenders price loans, forming beliefs—type scores—about borrowers' types. Since over-optimistic borrowers face worse income risk but incorrectly believe they are rational, both types behave identically. This gives rise to a tractable theory of type scoring as lenders cannot screen borrower types. Since rationals default less often, the partial pooling of borrowers generates cross-subsidization whereby over-optimists face lower than actuarially fair interest rates. Over-optimists make financial mistakes: they borrow too much and default too late. We calibrate the model to the US and quantitatively evaluate several policies to address these frictions: reducing the cost of default, increasing borrowing costs, imposing debt limits, and providing financial literacy education. While some policies lower debt and filings, they do not reduce over-borrowing. Financial literacy education can eliminate financial mistakes, but it also reduces behavioral borrowers' welfare by ending cross-subsidization. Score-dependent borrowing limits can reduce financial mistakes but lower welfare"--Abstract, page ii.

Permanent link to this Catalogue record:
publications.gc.ca/pub?id=9.894985&sl=0

Publication information
Department/Agency Bank of Canada, issuing body.
Title Consumer credit with over-optimistic borrowers / by Florian Exler, Igor Livshits, James MacGee and Michèle Tertilt.
Series title Staff working paper = Document de travail du personnel, 1701-9397 ; 2020-57
Publication type Series - View Master Record
Language [English]
Format Electronic
Electronic document
Note(s) "Last updated: December 29, 2020."
Includes bibliographical references (pages 40-43).
Publishing information Ottawa, Ontario, Canada : Bank of Canada = Banque du Canada, 2020.
©2020
Author / Contributor Exler, Florian, 1986- author.
Description 1 online resource (ii, 52 pages) : colour illustrations.
Catalogue number
  • FB3-5/2020-57E-PDF
Subject terms Consumer credit -- United States -- Econometric models.
Credit control -- United States -- Econometric models.
Bankruptcy -- United States -- Econometric models.
Crédit à la consommation -- États-Unis -- Modèles économétriques.
Crédit -- Politique gouvernementale -- États-Unis -- Modèles économétriques.
Faillite -- États-Unis -- Modèles économétriques.
Request alternate formats
To request an alternate format of a publication, complete the Government of Canada Publications email form. Use the form’s “question or comment” field to specify the requested publication.
Date modified: