What is the role of credit scores in credit markets? We argue that it is, in part, the market's assessment of a person's unobservable type, which here we take to be patience. We postulate a model of persistent hidden types where observable actions shape the public assessment of a person's type via Bayesian updating. We show how dynamic reputation can incentivize repayment. Importantly, we show how an economy with credit scores implements the same equilibrium allocation. We estimate the model using both credit market data and the evolution of individuals' credit scores. We conduct counterfactuals to assess how more or less information used in scoring individuals affects outcomes and welfare. If tracking of individual credit actions is outlawed, poor young adults of low type benefit from subsidization by high types despite facing higher interest rates arising from lower dynamic incentives to repay.

We study, theoretically and quantitatively, the general equilibrium of an economy in which households smooth consumption by means of both a riskless asset and unsecured loans with the option to default. The default option resembles a bankruptcy filing under Chapter 7 of the U.S. Bankruptcy Code. Competitive financial intermediaries offer a menu of loan sizes and interest rates wherein each loan makes zero profits. We prove the existence of a steady-state equilibrium and characterize the circumstances under which a household defaults on its loans. We show that our model accounts for the main statistics regarding bankruptcy and unsecured credit while matching key macroeconomic aggregates, and the earnings and wealth distributions. We use this model to address the implications of a recent policy change that introduces a form of “means testing” for households contemplating a Chapter 7 bankruptcy filing. We find that this policy change yields large welfare gains.

Lack of commitment at the time of auction to repayment of imminently maturing debt can generate a run on debt and immediate default. We show that the same lack of commitment leads to other possible self-fulfilling crises, including issuance of more debt at depressed prices, or a “sudden stop” (forced austerity) in which debt issuance is sharply curtailed. Both outcomes stem from the government's incentive to eliminate uncertainty about imminent payments at the time of auction by altering the level of debt issuance. These outcomes generate a large increase in spread volatility in both a 1-period and a multiperiod quantitative debt model.