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Health Shocks, Credit Scores, and Strategic Behavior with Credit Cards

The paper solves a puzzle related to unsecured credit and the use of credit scores. With credit scores increasingly present in credit decisions, and with the increased use of credit cards, especially in categories at risk of large negative health shocks, asymmetry of information between banks and individuals opens up wider possibilities for strategic behavior on the part of the latter. In this paper I analyze consumer strategic behavior in the credit market when faced with exogenous health shocks in the presence of banking institutions that rely on credit scores as a form of indicator of creditworthiness. By introducing multiple sources for asymmetry of information in the credit market, something not done in prior models, and introducing a dynamic discount factor, I find that the rational consumer engages in strategic behavior specific to their credit score. The paper solves an empirically parameterized model of life cycle consumption and borrowing focusing on unsecured credit and allowing for default in the presence of health shocks. It also allows for the simultaneous holding of both an interest bearing asset and unsecured debt. The findings support the hypothesis that exogenous credit shocks affect the behavior and the degree of strategy involved. While I do not possess actual consumer data on default, I develop some stylized empirical evidence in line with predictions of the theoretical model.