Consumer Credit

Measuring the Welfare Effects of Adverse Selection in Consumer Credit Markets

Anthony DeFusco (Northwestern), Huan Tang (LSE), Constantine Yanellis (Chicago)

Adverse selection is known in theory to lead to inefficiently low credit provision, yet empirical estimates of the resulting welfare losses are scarce. This paper leverages a randomized experiment conducted by a large fintech lender to estimate welfare losses arising from selection in the market for online consumer credit.

Building on methods from the insurance literature, we show how exogenous variation in interest rates can be used to estimate borrower demand and lender cost curves and recover implied welfare losses. While adverse selection leads to large equilibrium price distortions, we find only small overall welfare losses, particularly for high-credit-score borrowers.

• Platform randomly selected 11k applicants in Q1 2018.

• All qualified for credit, but were offered different rates

• High price: 36%; Low price: 21.5%

Policy implication: rate subsidy not quite helpful in this particular market