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Optimal Personal Bankruptcy Design under Moral Hazard

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Author Info
Borys Grochulski (Federal Reserve Bank of Richmond)
Abstract

In this paper, we develop a normative theory of unsecured consumer credit and personal bankruptcy based on the optimal trade-off between incentives and insurance. First, in order to characterize this trade-off, we solve a dynamic moral hazard problem in which agents' private effort decisions influence the life-cycle profiles of their earnings. We then show how the optimal allocation of individual effort and consumption can be implemented in a market equilibrium in which (i) agents and intermediaries repeatedly trade in secured and unsecured debt instruments, and (ii) agents obtain (restricted) discharge of their unsecured debts in bankruptcy. The structure of this equilibrium and the associated restrictions on debt discharge closely match the main qualitative features of personal credit markets and bankruptcy law that actually exist in the United States. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2009.06.004
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

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Handle: RePEc:red:issued:08-132

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Related research
Keywords: Bankruptcy; Unsecured credit; Moral hazard;

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Find related papers by JEL classification:
D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
K35 - Law and Economics - - Other Substantive Areas of Law - - - Personal Bankruptcy Law

References listed on IDEAS
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  1. Timothy J. Kehoe & David K. Levine, 2006. "Bankruptcy and Collateral in Debt Constrained Markets," NBER Working Papers 12656, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Stefania Albanesi & Christopher Sleet, 2006. "Dynamic Optimal Taxation with Private Information," Review of Economic Studies, Blackwell Publishing, vol. 73(1), pages 1-30, 01. [Downloadable!] (restricted)
    Other versions:
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This page was last updated on 2009-12-16.

This information is provided to you by IDEAS at the Department of Economics, College of Liberal Arts and Sciences, University of Connecticut using RePEc data on a server sponsored by the Society for Economic Dynamics.