Asymmetric Information and the Automobile Loan Market

Abstract

Information revelation can occur through a variety of mechanisms. For example, corporate finance research has established that a firm’s dividend policies provide investors with information about future growth prospects.¹ In addition, research on residential mortgages indicates that borrowers reveal their expected tenure through their choice of mortgage contracts.² As a result, lenders offer a menu of mortgage interest rate and point combinations in an effort to learn about borrower potential mobility.³ Similarly, lenders may anticipate how consumer debt will perform by observing the consumption choices that are being financed. With the proliferation of risk-based pricing in credit markets, lender’s ability to further differentiate between borrower credit risks, based on consumer choice of goods, offers lenders a potentially important source to enhance profitability, as well as the potential to extend credit to a wider range of borrowers.⁴

The authors would like to thank Michael Carhill, Erik Heitfield, Bert Higgins, Brad Jordan, Larry Mielnicki, Jim Papadonis, Kenneth Train, and Clifford Winston for helpful comments. We are grateful to Diana Andrade, Ron Kwolek, and Greg Pownell for excellent research assistance. The views expressed in this research are those of the authors and do not represent the policies or positions of the Office of the Comptroller of the Currency, of any offices, agencies, or instrumentalities of the U.S. Government, or of the Bank of America.