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Working Paper
A Quantitative Theory of Relationship Lending
Banks' loan pricing decisions reflect the fact that borrowers tend to have long-lasting relationships with lenders. Therefore, pricing decisions have an inherently dynamic component: high interest rates may yield higher static profits per loan, but in the long run they erode a banks' customer base and reduce future profitability. We study this tradeoff using a dynamic banking model which embeds lending relationships using deep habits (“customer capital”) and costs of adjusting loan portfolio composition. High customer capital raises the level and decreases the interest rate elasticity of ...
Working Paper
A Quantitative Theory of Relationship Lending
Borrower-lender relationships tend to be long-lasting, and borrowers switch lenders infrequently. We analyze the aggregate consequences of these facts in a model of heterogeneous banks subject to financial frictions that incorporates lending relationships as a form of customer capital for banks. The model's loan demand system is directly estimated on administrative loan-level data to recover key parameters governing the strength and persistence of relationships. The degree of market power deriving from lending relationships is consistent with a long run reduction in total credit of 4.1% ...
Working Paper
Lending Standards and Borrowing Premia in Unsecured Credit Markets
Using administrative data from Y-14M and Equifax, we find evidence for large spreads in excess of those implied by default risk in the U.S. unsecured credit market. These borrowing premia vary widely by borrower risk and imply a nearly flat relationship between loan prices and repayment probabilities, at odds with existing theories. To close this gap, we incorporate supply frictions – a tractably specified form of lending standards – into a model of unsecured credit with aggregate shocks. Our model matches the empirical incidence of both risk and borrowing premia. Both the level and ...
Working Paper
A Quantitative Theory of the Credit Score
What is the role of credit scores in credit markets? We argue that it is a stand-in for a market assessment of a person’s unobservable type (which here we take to be patience). We pose a model of persistent hidden types where observable actions shape the public assessment of a person’s type via Bayesian updating. We show how dynamic reputation can incentivize repayment without monetary costs of default beyond the administrative cost of filing for bankruptcy. Importantly, we show how an economy with credit scores implements the same equilibrium allocation. We estimate the model using both ...
Working Paper
A Quantitative Theory of Relationship Lending
Borrower-lender relationships tend to be long-lasting, and lender switching is infrequent. What are the aggregate consequences of these facts? We address this question in a model of heterogeneous banks subject to financial frictions. We incorporate lending relationships using loan portfolio adjustment costs for borrowers and accumulation of "relationship capital" for lenders. The model's implied loan demand system is directly estimated on administrative loan-level micro data to recover the key novel parameters governing the strength and persistence of lending relationships. We find that ...
Working Paper
A Quantitative Theory of the Credit Score
What is the role of credit scores in credit markets? We argue that it is a stand in for a market assessment of a person's unobservable type (which here we take to be patience). We pose a model of persistent hidden types where observable actions shape the public assessment of a person's type via Bayesian updating. We show how dynamic reputation can incentivize repayment without monetary costs of default beyond the administrative cost of filing for bankruptcy. Importantly we show how an economy with credit scores implements the same equilibrium allocation. We estimate the model using both ...