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Optimal Personal Bankruptcy Design under Moral Hazard

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  • 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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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 13 (2010)
Issue (Month): 2 (April)
Pages: 350-378

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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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References

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  1. Stefania Albanesi & Christopher Sleet, 2006. "Dynamic Optimal Taxation with Private Information," Review of Economic Studies, Oxford University Press, vol. 73(1), pages 1-30.
  2. Timothy J. Kehoe & David K. Levine, 2006. "Bankruptcy and collateral in debt constrained markets," Staff Report 380, Federal Reserve Bank of Minneapolis.
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Cited by:
  1. Kartik B. Athreya & Xuan S. Tam & Eric R. Young, 2012. "Debt default and the insurance of labor income risks," Economic Quarterly, Federal Reserve Bank of Richmond, issue 4Q, pages 255-307.
  2. Borghan Nezami Narajabad, 2012. "Information Technology and the Rise of Household Bankruptcy," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 15(4), pages 526-550, October.
  3. Juan Carlos Hatchondo & Leonardo Martinez & Juan M. Sanchez, 2011. "Mortgage defaults," Working Paper 11-05, Federal Reserve Bank of Richmond.
  4. Borys Grochulski, 2010. "On the optimality of Ramsey taxes in Mirless economies," Working Paper 10-14, Federal Reserve Bank of Richmond.

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