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Optimal personal bankruptcy design : A Mirrlees approach

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  • Borys Grochulski

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.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 08-05.

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Date of creation: 2008
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Handle: RePEc:fip:fedrwp:08-05

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Keywords: Bankruptcy ; Credit;

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Cited by:
  1. Pricila Maziero & Laurence Ales, 2008. "Accounting for private information," Working Papers 663, Federal Reserve Bank of Minneapolis.
  2. Kartik B. Athreya & Xuan S. Tam & Eric R. Young, 2009. "Are harsh penalties for default really better?," Working Paper 09-11, Federal Reserve Bank of Richmond.
  3. Casey B. Mulligan, 2009. "Means-Tested Mortgage Modification: Homes Saved or Income Destroyed?," NBER Working Papers 15281, National Bureau of Economic Research, Inc.

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