ABSTRACT
This chapter argues that the default approach is not a good test for discrimination that is due to prejudice. The default approach to test for discrimination is based on the fact that the loan approval process may lead to a selected sample of approved loans. The chapter also argues that the default approach is a poor test if the correlation between unobservables in the loan approval and default equations is small. It shows that assumptions made in the default approach are inconsistent with current findings of racial differences in loan approval, such as the results of Munnell et al. The chapter presents the possibility that minority loans may be riskier than majority loans after controlling for variables that are observable at loan approval. The effect can be found by estimating both the race coefficient in a model of potential lender loss for all approved loans and the race coefficient in a model of actual lender loss for defaulted loans.
