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Information Technology and the Rise of Household Bankruptcy

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  • N. Narajabad, Borghan
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    Abstract

    Several studies attributed the rise of household bankruptcy in the past two decades to the decline of social stigma associated with default. Stigma explanations, however, cannot account for the increase of credit availability during this period. I try to explain both of these facts as a result of a more informative credit rating technology. I study an adverse selection environment where borrowers are heterogeneous with respect to their cost of default. Creditors have access to a rating technology which provides an exogenous signal about borrowers' default costs. Equilibrium contracts subject each borrower to a credit limit such that the creditors' expected profit, conditional on the signal about the borrower's default cost, is zero. As the exogenous signal becomes more informative, the credit market will provide higher credit limits for borrowers with high default costs, and lowers credit limits of borrowers with low costs of default. Hence a more informative signal allows those with high default costs to borrow more, making them more likely to default, while decreasing borrowing and default by those with low default costs. Using Simulated Method of Moments, I estimate the model parameters to match the increases in the average consumer credit card limit, the average unsecured consumer debt level and the spread of the credit limit distribution from 1992 to 1998 using the Survey of Consumer Finance's data. The model does well in matching the targeted moments and can account for one third to half of the increase in the number of bankruptcy filings from 1992 to 1998.

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    Bibliographic Info

    Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 21058.

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    Date of creation: 01 Mar 2010
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    Handle: RePEc:pra:mprapa:21058

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    Related research

    Keywords: Consumer Bankruptcy; Information and Market Efficiency; Rating Agencies.;

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    References

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    1. Igor Livshits & James MacGee & Michele Tertilt, 2006. "Accounting for the Rise in Consumer Bankruptcies," University of Western Ontario, Economic Policy Research Institute Working Papers 20066, University of Western Ontario, Economic Policy Research Institute.
    2. Wendy Edelberg, 2003. "Risk-based pricing of interest rates in household loan markets," Finance and Economics Discussion Series 2003-62, Board of Governors of the Federal Reserve System (U.S.).
    3. Satyajit Chatterjee & Dean Corbae & Makoto Nakajima & José-Víctor Ríos-Rull, 2007. "A Quantitative Theory of Unsecured Consumer Credit with Risk of Default," Econometrica, Econometric Society, vol. 75(6), pages 1525-1589, November.
    4. Wenli Li & Pierre-Daniel G. Sarte, 2002. "The macroeconomics of U.S. consumer bankruptcy choice : chapter 7 or chapter 13?," Working Paper 02-01, Federal Reserve Bank of Richmond.
    5. Aiyagari, S Rao, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, MIT Press, vol. 109(3), pages 659-84, August.
    6. Xavier Mateos-Planas, 2011. "Credit Lines," 2011 Meeting Papers 1293, Society for Economic Dynamics.
    7. Kartik Athreya, 2004. "Shame as it ever was : stigma and personal bankruptcy," Economic Quarterly, Federal Reserve Bank of Richmond, issue Spr, pages 1-19.
    8. Jaromir B. Nosal & Lukasz A. Drozd, 2008. "Competing for Customers: A Search Model of the Market for Unsecured Credit," 2008 Meeting Papers 274, Society for Economic Dynamics.
    9. Kartik Athreya & Xuan S. Tam & Eric R. Young, 2012. "A Quantitative Theory of Information and Unsecured Credit," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(3), pages 153-83, July.
    10. Jim MacGee & Igor Livshits & Michele Tertilt, 2008. "Costly Contracts and Consumer Credit," 2008 Meeting Papers 385, Society for Economic Dynamics.
    11. Ausubel, Lawrence M, 1991. "The Failure of Competition in the Credit Card Market," American Economic Review, American Economic Association, vol. 81(1), pages 50-81, March.
    12. Juan M. Sanchez, 2009. "The role of information in the rise in consumer bankruptcies," Working Paper 09-04, Federal Reserve Bank of Richmond.
    13. Paul S. Calem & Michael B. Gordy & Loretta J. Mester, 2005. "Switching costs and adverse selection in the market for credit cards: new evidence," Working Papers 05-16, Federal Reserve Bank of Philadelphia.
    14. Ian Domowitz & Robert L. Sartain, 1999. "Determinants of the Consumer Bankruptcy Decision," Journal of Finance, American Finance Association, vol. 54(1), pages 403-420, 02.
    15. David B. Gross & Nicholas S. Souleles, 2001. "Do Liquidity Constraints and Interest Rates Matter for Consumer Behavior? Evidence from Credit Card Data," NBER Working Papers 8314, National Bureau of Economic Research, Inc.
    16. Huggett, Mark, 1993. "The risk-free rate in heterogeneous-agent incomplete-insurance economies," Journal of Economic Dynamics and Control, Elsevier, vol. 17(5-6), pages 953-969.
    17. David B. Gross & Nicholas S. Souleles, 2001. "An Empirical Analysis of Personal Bankruptcy and Delinquency," NBER Working Papers 8409, National Bureau of Economic Research, Inc.
    18. Scott Fay & Erik Hurst & Michelle J. White, 2002. "The Household Bankruptcy Decision," American Economic Review, American Economic Association, vol. 92(3), pages 706-718, June.
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    Cited by:
    1. Livshits, Igor & MacGee, James & Tertilt, Michèle, 2011. "Costly Contracts and Consumer Credit," CEPR Discussion Papers 8580, C.E.P.R. Discussion Papers.
    2. Xavier Gine & Jessica Goldberg & Dean Yang, 2012. "Credit Market Consequences of Improved Personal Identification: Field Experimental Evidence from Malawi," American Economic Review, American Economic Association, vol. 102(6), pages 2923-54, October.

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