Student Loans and Repayment: Theory, Evidence and Policy

In this paper we explore alternative models for insurance and incentives problems and assess them in terms of the implied behavior for human capital investment, consumption and default. We consider models with exogenously specified market incompleteness as well as models in which imperfect insurance arises endogenously from incentive problems. We derived sharp predictions from stylized versions of standard models in the literature. However, we go also beyond existing literature by considering hybrid models, in which combinations of two or three incentives problems are present. We find that all standard models (with only one incentive problem) produce counterfactual implications for either investment and/or for the behavior of default and consumption. Our preferred models because of their implied credit terms (interest rates), investments and default are (1) limited commitment with exogenously non-contingent repayments and (2) moral hazard combined with costly state verification.