“The Impact of Discriminatory Pricing Based on Customer Risk: An Empirical Investigation using Indirect Lending through Retail Networks”
by Dr. Christopher Amaral
Queen’s University
Abstract
Consumer credit, which refers to loans and lines extended to individual consumers, is unique since pricing is often disperse, enabling lenders to customize pricing by consumer. One of the pricing strategies that has emerged within the consumer credit sector is risk-based pricing, which involves the classification of borrowers into consumer risk segments that are each priced differently (Magri 2015). In this paper, we investigate the profit implications of risk-based pricing in the context of indirect lending. Using individual-level loan data, we build a three-stage model of choice that accounts for the (1) agent’s decision to select a loan rate to offer the customer from the menu of prices (i.e. rate sheet), (2) lender’s decision to approve or not approve a loan application, and (3) the customer’s decision to accept or reject a loan offer. Given the estimation results, we optimize the loan rate and agent incentive for each risk segment and calculate the expected lift in profits for the lender. The results suggest that implementation of risk-based pricing leads to double digit increases in the financial institution’s profits.
Keywords: Price Discrimination, Price Optimization, Consumer Credit, Risk-Based Pricing, Financial Services, Sales Incentives
