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The role of information in the rise in consumer bankruptcies

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Juan M. Sanchez

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Abstract

Consumer bankruptcies rose sharply over the last 20 years in the U.S. economy. During the same period, there was impressive technological progress in the information sector. This paper provides a theory to understand and quantify the role of improvements in information technologies in consumer credit markets. Informational frictions restrict the amount of debt that can be borrowed. In fact, in the equilibrium in which investing in information is too expensive, many households borrow such small amounts that the default risk is very low. When information costs drop and informational frictions vanish, those households borrow more and default is likely after a bad shock. Quantitative exercises show that information costs have a significant effect on the bankruptcy rate. Additionally, a drop in information costs generates changes in other variables (e.g. interest rate dispersion) similar to what has occurred over the last 20 years.

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Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 09-04.

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Date of creation: 2009
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Handle: RePEc:fip:fedrwp:09-04

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Keywords: Bankruptcy ; Consumer credit;

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  1. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Blackwell Publishing, vol. 48(2), pages 289-309, April. [Downloadable!] (restricted)
  2. Enrique G. Mendoza & Vivian Z. Yue, 2008. "A Solution to the Default Risk-Business Cycle Disconnect," NBER Working Papers 13861, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Aguiar, Mark & Gopinath, Gita, 2006. "Defaultable debt, interest rates and the current account," Journal of International Economics, Elsevier, vol. 69(1), pages 64-83, June. [Downloadable!] (restricted)
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  4. Greenwood, Jeremy & Sanchez, Juan M & Wang, Cheng, 2007. "Financing Development: The Role of Information Costs," Staff General Research Papers 12848, Iowa State University, Department of Economics. [Downloadable!]
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  5. Chatterjee, Satyajit & Corbae, Dean & Ríos-Rull, José-Víctor, 2008. "A finite-life private-information theory of unsecured consumer debt," Journal of Economic Theory, Elsevier, vol. 142(1), pages 149-177, September. [Downloadable!] (restricted)
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  6. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June. [Downloadable!]
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  7. Berger, Allen N, 2003. " The Economic Effects of Technological Progress: Evidence from the Banking Industry," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(2), pages 141-76, April.
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  8. Kartik Athreya & Xuan S. Tam & Eric R. Young, 2008. "A quantitative theory of information and unsecured credit," Working Paper 08-06, Federal Reserve Bank of Richmond. [Downloadable!]
  9. Eva Carceles Poveda & Arpad Abraham, 2004. "Endogenous Trading Constraints with Incomplete Asset Markets," 2004 Meeting Papers 667, Society for Economic Dynamics.
  10. Riley, John G, 1979. "Informational Equilibrium," Econometrica, Econometric Society, vol. 47(2), pages 331-59, March. [Downloadable!] (restricted)
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  11. Enrique G. Mandoza & Vivian Z. Yue, 2008. "A solution to the default risk-business cycle disconnect," International Finance Discussion Papers 924, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  12. Edelberg, Wendy, 2006. "Risk-based pricing of interest rates for consumer loans," Journal of Monetary Economics, Elsevier, vol. 53(8), pages 2283-2298, November. [Downloadable!] (restricted)
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