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Liquidity Constraints and Imperfect Information in Subprime Lending

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We present new evidence on consumer liquidity constraints and the credit market conditions that might give rise to them. We analyze unique data from a large auto sales company serving the subprime market. Short-term liquidity appears to be a key driver of consumer behavior. Demand increases sharply during tax rebate season and purchases are highly sensitive to down-payment requirements. Lenders also face substantial informational problems. Default rates rise significantly with loan size, providing a rationale for loan caps, and higher-risk borrowers demand larger loans. This adverse selection is mitigated, however, by risk-based pricing.

Document Type: Research Article

DOI: http://dx.doi.org/10.1257/aer.99.1.49

Publication date: March 1, 2009

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