Building Credit History with Heterogeneously Informed Lenders

Abstract

This paper examines a novel mechanism of credit-history building as a way of aggregating information across multiple lenders. We build a dynamic model with multiple competing lenders, who have heterogeneous private information about a consumer's creditworthiness, and extend credit over multiple stages. Acquiring a loan at an early stage serves as a positive signal-it allows the borrower to convey to other lenders the existence of a positively informed lender (advancing that early loan)-thereby convincing other lenders to extend further credit in future stages. This signaling may be costly to the least risky borrowers for two reasons. First, taking on an early loan may involve cross-subsidization from the least risky borrowers to more risky borrowers. Second, the least risky borrowers may take inefficiently large loans relative to the symmetric-information benchmark. We demonstrate that, despite these two possible costs, the least risky borrowers often prefer these equilibria to those without information aggregation. Our analysis offers an interesting and novel insight into debt dilution. Contrary to the conventional wisdom, repayment of the early loan is more likely when a borrower subsequently takes on a larger rather than a smaller additional loan. This result hinges on a selection effect: larger subsequent loans are only given to the least risky borrowers.

Who Bears the Welfare Costs of Monopoly? The Case of the Credit Card Industry

“…Others, including Bizer and DeMarzo (1992), Hatchondo and Martinez (2018), and Kovrijnykh, Livshits, and Zetlin-Jones (2019), consider borrowing without commitment. Closest to us is Hatchondo and Martinez (2018), who consider one-period loans without commitment.…”

Who Bears the Welfare Costs of Monopoly? The Case of the Credit Card Industry

“…Others, including Bizer and DeMarzo (1992), Hatchondo andMartinez (2018), andKovrijnykh, Livshits, andZetlin-Jones (2019), consider borrowing without commitment. Closest to us is Hatchondo and Martinez (2018), who consider one-period loans without commitment.…”

“…We develop a Bewley-Huggett-Aiyagari framework in which a finite number of non-atomistic credit card firms strategically compete for customers. Our model features defaultable debt and non-exclusive credit lines, complementing the work of Bizer and DeMarzo (1992), Hatchondo and Martinez (2018), and Kovrijnykh, Livshits, and Zetlin-Jones (2019).…”

“…Drozd and Nosal (2008), Raveendranathan (2020), andBraxton et al (2018) incorporate long-term credit lines into models with imperfect competition (via search and bargaining) in the credit market. Others, including Bizer and DeMarzo (1992), Hatchondo and Martinez (2018), and Kovrijnykh et al (2019), consider borrowing without commitment. Closest to us are Hatchondo and Martinez (2018), who consider one-period loans without commitment.…”

Who Bears the Welfare Costs of Monopoly? The Case of the Credit Card Industry

“…Others, including Bizer and DeMarzo (1992), Hatchondo and Martinez (2018), and Kovrijnykh, Livshits, and Zetlin-Jones (2019), consider borrowing without commitment. Closest to us is Hatchondo and Martinez (2018), who consider one-period loans without commitment.…”