Study finds credit score changes affect default rate even if underlying record hasn’t changed

Amiyatosh Purnanandam, and Alexander Wirth, both of the University of Michigan, Stephen M. Ross School of Business, have written Can Credit Rating Affect Credit Risk? Causal Evidence from an Online Lending Marketplace. Here’s the abstract:

Credit rating is determined by a borrower’s credit risk, but can the rating in itself change a borrower’s credit risk in an economically meaningful manner? Despite the theoretical and practical importance of this question, there is limited empirical evidence on this topic since it is hard to obtain variation in credit rating that is independent of the fundamentals. Using a regulatory change in March 2020 that provides a credibly exogenous variation in the credit rating of borrowers with similar risk, we show that one standard deviation higher FICO score causes a reduction of 76% in the default rate of borrowers over the following year. Our findings suggest that empirical studies linking credit ratings to real outcomes should carefully consider the endogenous effect of ratings on future outcomes. These findings also show that frequent incidence of erroneous credit bureau data imposes economically large long-term costs on consumers.

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