To Loan or Not to Loan

1
To Loan or Not to Loan

• Terminology
• Prime borrowers
• Prime interest rate
• Sub-prime borrowers
• Adverse Selection
• Moral Hazard
• Credit Score

2
Adverse Selection Example Cars

• Problem setup
• Suppose that there are 6 qualities of car, q,
  equal to 0,1/4,1/2,3/4,1,5/4,3/2,7/4,2.
• The value of the car to the owners isgiven by
  1000q
• The value of each car to potential buyers who
  know the quality is 1500q.

3
Single Variable Regression
Coefficient of theindependent variable
Interceptcoefficient
DependentVariable
Independentvariable
Coefficient ofDetermination
R2
4
Example
R2 .41
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