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Former CREA Working Papers |
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Working Papers # 359 | | Title: | Loans, Insurance and Failures in the Credit Market for Students | | Authors: | by Elena Del Rey, Bertrand Verheyden | | Date: | 31-08-2008 | | Keywords: | ex-post moral hazard, adverse selection, income contingent loans | | JEL Codes: | D82, I22 | | Abstract: | | Whereas public student loans are often income contingent, private banks typically off er pure
loans, or don't off er loans at all. In order to provide a rationale for these observations, we present a model with perfectly competitive banks and risk averse students who have private information on their ability to learn. We show that the combination of ex-post moral hazard and adverse selection produces credit market rationing when default penalties are low. Intermediate levels of default penalties can result in the existence of an equilibrium that pools together ability types. However, pooling contracts are not insuring at equilibrium, which implies a second type of credit market failure. Finally, if default penalties are large enough, equilibrium contracts provide less able students with insurance against the eventuality of a bad outcome, just in the income contingent loan fashion. The model is also used to explain other stylized facts, such as the positive impact of returns to education and interest rate subsidies on the development of the student loan market. Also, it explains why, unlike banks, governments o er income contingent loans. | | Download this paper in a PDF file (501.57 Kb) |  Back to the list |
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