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Research Abstracts Online
January 2010 - March 2011

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University of Minnesota Twin Cities
College of Liberal Arts
Department of Economics

PI: Varadarajan V. Chari

Competing for Customers: A Search Model of the Market for Unsecured Credit

These researchers have proposed a theory of the unsecured credit market that explicitly models the main financial instrument used in this market nowadays: credit cards. Credit cards offer households additional insurance against bad shocks when compared to more traditional forms of lending. In particular, when compared to 1-period loan contracts modeled so far in the literature (a la Eaton and Gersovitz (1981)), credit cards offer more financial flexibility to households and banks, and imply more default in equilibrium. In particular, on the household side, a pre-approved credit line offers cheaper access to credit, in particular in periods of financial distress. On the bank side, the researchers’ modeling of credit cards as long-term contracts with commitment allows the bank to use inter-temporal transfers of revenues to cover the cost of default – thus making higher default rates consistent with profit maximizing behavior. The researchers are creating a quantitative assessment of these effects in a fully parameterized model. The solution of the model with credit cards requires an evaluation of profit and value functions for all possible combinations of credit lines and interest rates, which is a very computationally intensive task. The researchers have been using MSI resources to solve the model in a parallel environment on around 100 processors.

Group Members

Lukasz Drozd, Department of Finance, Wharton School of Business, University of Pennsylvania, Philadelphia, Pennsylvania
Jaromir Nosal, Department of Economics, Columbia University, New York, New York