Dealer Financing in the Subprime Auto Market: Markups and Implicit Subsidies

Do dealers use their financing discretion to charge higher interest rate markups to high-risk customers? We use unique transaction-level data to examine finance and vehicle profits in the subprime auto market with three main results. First, financing subprime customers is costly for dealerships because of loan discounts that are only partially offset by proceeds from interest rate markups. Second, financing is costliest to dealers for deep subprime customers with low credit scores and low incomes. Third, instead of offsetting financing costs, vehicle markups are lowest for deep subprime customers. Finance margins and vehicle markups are also positively correlated more generally. This paper was accepted by Tomasz Piskorski, finance. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2021.04086 .