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Credit card debt and default over the life-cycle

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  • Lopes, Paula

Abstract

This paper solves an empirically parameterised model of life-cycle consumption which extends the precautionary savings models of Carroll (1997), and Deaton (1991), to allow for uncollaterized borrowing and default. In case households choose to default: (i) their access to credit markets is restricted; (ii) lenders of funds may seize their financial assets above an exemption level, and up to the amount of outstanding debt; and (iii) there is a “stigma effect,” or a decrease in current utility caused by the social embarrassment of declaring bankruptcy. The model shows that the decisions to borrow and default are closely related to the shape of the life-cycle labor income profile, and henceforth vary across household education levels. Moreover, the model explains two puzzling empirical facts: (a) why bankruptcy rates have been growing in periods of economic expansion and low unemployment; and, (b) why households hold simultaneously high cost debt and low return assets.

Suggested Citation

  • Lopes, Paula, 2003. "Credit card debt and default over the life-cycle," LSE Research Online Documents on Economics 24869, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:24869
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    File URL: http://eprints.lse.ac.uk/24869/
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    References listed on IDEAS

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    5. Hubbard, R. Glenn & Skinner, Jonathan & Zeldes, Stephen P., 1994. "The importance of precautionary motives in explaining individual and aggregate saving," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 40(1), pages 59-125, June.
    6. Andreas Lehnert & Dean M. Maki, 2002. "Consumption, debt and portfolio choice: testing the effect of bankruptcy law," Finance and Economics Discussion Series 2002-14, Board of Governors of the Federal Reserve System (U.S.).
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    Cited by:

    1. Andrew Benito & Haroon Mumtaz, 2006. "Consumption excess sensitivity, liquidity constraints and the collateral role of housing," Bank of England working papers 306, Bank of England.

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    More about this item

    Keywords

    consumer credit; life cycle; credit card; personal bankruptcy;
    All these keywords.

    JEL classification:

    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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