On the Economics of Discrimination in Credit Markets

Abstract

This paper develops a general equilibrium model of both taste-based and statistical discrimination in credit markets. We find that both types of discrimination have similar predictions for intergroup differences in loan terms. The commonly held view has been that if there exists taste-based discrimination, loans approved to minority borrowers would have higher expected profitability than to majorities with comparable credit background. We show that the validity of this profitability view depends crucially on how expected loan profitability is measured. We also show that there must exist taste-based discrimination if loans to minority borrowers have higher expected rate of return or lower expected rate of default loss than to majorities with the same exogenous characteristics at the time of loan origination. Empirical evidence on expected rate of default loss cannot reject the null hypothesis of non-existence of taste-based discrimination.