Adverse selection in the retail credit card market in South Africa.

Segoale, Elizabeth Lettie.
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ABSTRACT Adverse selection is a deterrent to the efficient functioning of markets that arises when one party to the transaction has more information than the other. In financial markets, adverse selection could lead to an overinvestment in the high risk customer pools resulting in unforeseen credit losses. This paper examines the results of preapproved credit limit increases for evidence of adverse selection. Using an Econometrics approach, the research analyses campaign data from a large South African financial institution. Descriptive results are presented to reach the conclusion that: a) Respondents to credit limit increase solicitations are worse credit risks that Non Respondents, b) there are immediate credit quality changes following the acceptance of the offer and, c) the cardholder defaults following the limit increase. Although this paper is closely aligned to research undertaken by Ausubel (1999) and Argawal et al. (2010), who also examine the existence of adverse selection in the credit card market, it provides additional evidence of adverse selection despite the use of robust screening techniques to minimise information asymmetries between the lender and the borrower.
MBA 2014
Credit cards, Consumer credit