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The option value of consumer bankruptcy

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  • Ethan Cohen-Cole

Abstract

This paper aims to contribute to the growing literature on the causes of consumer bankruptcy. It presents the consumer bankruptcy decision as an irreversible choice that has an embedded real option value. This allows the use of well known framework for the study of decision making under uncertainty. The principal empirical finding is that cross-sectional variances of economic factors, such as unemployment, are strong predictors of bankruptcy rates and are consistent with the implications of the real options model. This supports anecdotal evidence that individuals are facing increased economic uncertainty and that suggests that uninsurable economic shocks are poorly characterized by local information. Finally, the paper concludes that policy regarding changes in the bankruptcy rate may have been disproportionately focused on credit variables such as utilization rates and supply of credit rather than exposure to risk.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Boston in its series Risk and Policy Analysis Unit Working Paper with number QAU09-1.

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Date of creation: 2009
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Handle: RePEc:fip:fedbqu:qau09-1

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Keywords: Bankruptcy;

This paper has been announced in the following NEP Reports:

References

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  1. Michelle J. White, 2007. "Bankruptcy Reform and Credit Cards," NBER Working Papers 13265, National Bureau of Economic Research, Inc.
  2. Igor Livshits & James MacGee & Michèle Tertilt, 2010. "Accounting for the Rise in Consumer Bankruptcies," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 165-93, April.
  3. Geske, Robert & Johnson, Herb E, 1984. " The American Put Option Valued Analytically," Journal of Finance, American Finance Association, American Finance Association, vol. 39(5), pages 1511-24, December.
  4. Ethan Cohen-Cole & Burcu Duygan-Bump, 2008. "Household bankruptcy decision: the role of social stigma vs. information sharing," Risk and Policy Analysis Unit Working Paper, Federal Reserve Bank of Boston QAU08-6, Federal Reserve Bank of Boston.
  5. Steven J. Haider, 2000. "Earnings Instability and Earnings Inequality of Males in the United States: 1967-1991," Working Papers, RAND Corporation Publications Department 00-15, RAND Corporation Publications Department.
  6. Satyajit Chatterjee & Dean Corbae & Makoto Nakajima & Jose-Victor Rios-Rull, 2002. "A Quantitative Theory of Unsecured Consumer Credit with Risk of Default," Centro de Alti­simos Estudios Ri­os Pe©rez(CAERP), Centro de Altisimos Estudios Rios Perez (CAERP) 2, Centro de Altisimos Estudios Rios Perez (CAERP).
  7. Scott Fay & Erik Hurst & Michelle J. White, 2002. "The Household Bankruptcy Decision," American Economic Review, American Economic Association, American Economic Association, vol. 92(3), pages 706-718, June.
  8. Athreya, Kartik B., 2002. "Welfare implications of the Bankruptcy Reform Act of 1999," Journal of Monetary Economics, Elsevier, Elsevier, vol. 49(8), pages 1567-1595, November.
  9. McDonald, Robert & Siegel, Daniel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 101(4), pages 707-27, November.
  10. David B. Gross & Nicholas S. Souleles, 1999. "An Empirical Analysis of Personal Bankruptcy and Delinquency," Center for Financial Institutions Working Papers, Wharton School Center for Financial Institutions, University of Pennsylvania 98-28, Wharton School Center for Financial Institutions, University of Pennsylvania.
  11. Igor Livshits & James MacGee & Michele Tertilt, 2005. "Consumer Bankruptcy: A Fresh Start," Discussion Papers, Stanford Institute for Economic Policy Research 04-011, Stanford Institute for Economic Policy Research.
  12. Christopher D. Carroll, 1992. "The Buffer-Stock Theory of Saving: Some Macroeconomic Evidence," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 23(2), pages 61-156.
  13. Robert A. Moffitt & Peter Gottschalk, 2002. "Trends in the Transitory Variance of Earnings in the United States," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 112(478), pages C68-C73, March.
  14. Kartik Athreya, 2004. "Shame as it ever was : stigma and personal bankruptcy," Economic Quarterly, Federal Reserve Bank of Richmond, Federal Reserve Bank of Richmond, issue Spr, pages 1-19.
  15. Li, Wenli & Sarte, Pierre-Daniel, 2006. "U.S. consumer bankruptcy choice: The importance of general equilibrium effects," Journal of Monetary Economics, Elsevier, Elsevier, vol. 53(3), pages 613-631, April.
  16. Michelle J. White, 2007. "Bankruptcy Reform and Credit Cards," Journal of Economic Perspectives, American Economic Association, vol. 21(4), pages 175-200, Fall.
  17. Daly, Mary C. & Valletta, Robert G., 2008. "Cross-national trends in earnings inequality and instability," Economics Letters, Elsevier, Elsevier, vol. 99(2), pages 215-219, May.
  18. Ethan Cohen-Cole, 2008. "Credit card redlining," Risk and Policy Analysis Unit Working Paper, Federal Reserve Bank of Boston QAU08-1, Federal Reserve Bank of Boston.
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