“Multideimensional heterogeneity and nature of selection in consumer credit market” by Keunkwan Ryu
Seoul National University
Consumers in the credit market are heterogeneous not only in their risk type but also in their inter-temporal elasticity of substitution (IES). Like for firms, unmeasured heterogeneity in risk type causes a positive relation between interest rate and default. Unlike for firms, though, unmeasured heterogeneity in IES causes a negative relation between interest rate and default. It is because consumers with a lower degree of IES enjoy a bigger utility gain from inter-temporal consumption smoothing, suffer more from denial of access to the consumer credit market, and thus face a stronger incentive to avoid default by honoring existing debts. By estimating proportional hazard models with varying sets of control variables, we have found that once observable risk factors are controlled for those consumers who borrow money at a higher interest rate are not more but less likely to default, an evidence counter to Stiglitz and Weiss (1981)'s theoretical prediction on borrowing firms. Consumers are not like firms in the credit market.