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Personal bankruptcy and post-bankruptcy liquidity constraint

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  • Lee, Ho-Seok
  • Lim, Byung Hwa

Abstract

Once a debtor files for bankruptcy under Chapter 7, all or some of the unsecured debts are discharged and the debtor is endowed with a financial fresh start. However, a post-bankruptcy consumer faces restrictions on borrowing against future income and is likely to be liquidity constrained. This paper intends to provide a quantitative analysis regarding the effects of limits for borrowing against future income imposed on a post-bankruptcy consumer. We obtain explicit expressions for the optimal consumption, investment in the risky asset, and discretionary bankruptcy decision through a duality approach when there exists a liquidity constraint after bankruptcy. The quantitative results show that a post-bankruptcy constraint has significant impacts on a debtor’s consumption, investment, and bankruptcy wealth level. The effects of an opportunity to file for bankruptcy compete with those of post-bankruptcy liquidity constraints. We find the criterion for the latter to dominate the former. We also provide implications on the expected time to bankruptcy.

Suggested Citation

  • Lee, Ho-Seok & Lim, Byung Hwa, 2023. "Personal bankruptcy and post-bankruptcy liquidity constraint," Journal of Banking & Finance, Elsevier, vol. 152(C).
    • Handle: RePEc:eee:jbfina:v:152:y:2023:i:c:s0378426623000857
    DOI: 10.1016/j.jbankfin.2023.106861
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    References listed on IDEAS

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    More about this item

    Keywords

    Bankruptcy; Consumption and investment; Liquidity constraint; Duality approach;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • G51 - Financial Economics - - Household Finance - - - Household Savings, Borrowing, Debt, and Wealth

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