Worst of the good and best of the bad: Adverse selection consequences of risk pricing

Abstract

Why do lenders shrink back from full risk pricing in certain credit markets, even when a sophisticated system of credit scoring is already in place? Fear of bad publicity is the usual reason cited but this paper offers a complementary explanation which suggests that there may be an underlying financial process driving such behaviour. The key proposition of the paper is that risk pricing can cause adverse selection which has the potential to mitigate any positive benefits such a pricing strategy may bring to the lender. This explanation is developed by introducing risk pricing into the seminal Stiglitz and Weiss model and in so doing offers the first substantial link between the risk assessment and credit rationing literatures.

Citation

Pryce, G. (2003), "Worst of the good and best of the bad: Adverse selection consequences of risk pricing", Journal of Property Investment & Finance, Vol. 21 No. 6, pp. 450-472. https://doi.org/10.1108/14635780310508621