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Credit Card Debt and Default over the Life-Cycle

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  • Paula Lopes

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 e.ect,¶ 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

  • Paula Lopes, 2003. "Credit Card Debt and Default over the Life-Cycle," FMG Discussion Papers dp470, Financial Markets Group.
    • Handle: RePEc:fmg:fmgdps:dp470
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    1. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-396, March.
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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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