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We analyze subprime consumer lending and the role played by down payment requirements in screening high-risk borrowers and limiting defaults. To do this, we develop an empirical model of the demand for financed purchases that incorporates both adverse selection and repayment incentives. We estimate the model using detailed transaction-level data on subprime auto loans. We show how different elements of loan contracts affect the quality of the borrower pool and subsequent loan performance. We also evaluate the returns to credit scoring that allows sellers to customize financing terms to individual applicants. Our approach shows how standard econometric tools for analyzing demand and supply under imperfect competition extend to settings in which firms care about the identity of their customers and their postpurchase behavior.
This is the peer reviewed version of the following article, which has been published in final form at http://dx.doi.org/10.3982/ECTA7677. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving.
Einav, L., Jenkins, M., & Levin, J. (2012). Contract Pricing in Consumer Credit Markets. Econometrica, 80 (4), 1387-1432. http://dx.doi.org/10.3982/ECTA7677
Date Posted: 27 November 2017
This document has been peer reviewed.