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The Role of Information in Consumer Debt and Bankruptcy

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  • Juan M. Sanchez

    (University of Rochester)

Abstract

Consumer debt and bankruptcy are central issues today because of their explosive trends over the last 20 years in the U.S. economy. However, there is no convincing explanation for these facts. A drop in information costs, a potential cause, has not been evaluated mainly because there is no quantitative theory of consumer debt and bankruptcy where the cost of information plays an important role. This paper provides such a theory and quantifies how much of the rise in debt and bankruptcy can be attributed to the drop in information costs. In the model, lenders offer contracts specifying both interest rates and borrowing limits. In equilibrium, the contracts with low interest rates have tight borrowing limits, while those with high interest rates have loose borrowing limits. Despite being borrowing constrained, low-risk individuals prefer to borrow at the low interest rate. Conversely, high-risk individuals prefer to borrow more at higher interest rates. As the costs of information drop, it may be possible to explicitly condition loans on an individual’s risk. This allows previously borrowing constrained individuals to borrow more. As a result, there is also more bankruptcy because the benefits of filing bankruptcy are increasing in the debt size. The quantitative importance of this mechanism is then investigated by calibrating the model’s parameters to match moments for the years 1983 and 2004. The model can successfully match key data moments for both years varying only the cost of information and the income distribution. To quantify the effect of the drop in information costs over the last 20 years, two counterfactual economies are computed. The main finding is that the drop in information costs alone generates around 40% of the total rise in consumer bankruptcy.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 523.

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Date of creation: 2008
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Handle: RePEc:red:sed008:523

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  1. Igor Livshits & James MacGee & Michèle Tertilt, 2007. "Accounting for the Rise in Consumer Bankruptcies," NBER Working Papers 13363, National Bureau of Economic Research, Inc.
  2. Michelle J. White, 2007. "Bankruptcy Reform and Credit Cards," NBER Working Papers 13265, National Bureau of Economic Research, Inc.
  3. Satyajit Chatterjee & Dean Corbae & Makoto Nakajima & Jose-Victor Rios-Rull, 2007. "A quantitative theory of unsecured consumer credit with risk of default," Working Papers 07-16, Federal Reserve Bank of Philadelphia.
  4. Jeremy Greenwood & Juan M. Sanchez & Cheng Wang, 2010. "Financing Development: The Role of Information Costs," American Economic Review, American Economic Association, American Economic Association, vol. 100(4), pages 1875-91, September.
  5. Ábrahám, Árpád & Cárceles-Poveda, Eva, 2010. "Endogenous trading constraints with incomplete asset markets," Journal of Economic Theory, Elsevier, Elsevier, vol. 145(3), pages 974-1004, May.
  6. Satyajit Chatterjee & Dean Corbae & Jose-Victor Rios-Rull, 2006. "Finite-Life, Private-Information Theory of Unsecured Debt," 2006 Meeting Papers, Society for Economic Dynamics 781, Society for Economic Dynamics.
  7. Jaffee, Dwight M & Russell, Thomas, 1976. "Imperfect Information, Uncertainty, and Credit Rationing," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 90(4), pages 651-66, November.
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Cited by:
  1. Leonardo Martinez & Juan Carlos Hatchondo & Cesar Sosa Padilla, 2011. "Debt Dilution and Sovereign Default Risk," IMF Working Papers, International Monetary Fund 11/70, International Monetary Fund.
  2. Leonardo Martinez & Juan Carlos Hatchondo, 2008. "A model of credit risk without commitment," 2008 Meeting Papers, Society for Economic Dynamics 940, Society for Economic Dynamics.
  3. Kartik Athreya & Xuan S. Tam & Eric R. Young, 2011. "A quantitative theory of information and unsecured credit," Working Paper, Federal Reserve Bank of Richmond 08-06, Federal Reserve Bank of Richmond.
  4. Juan Carlos Hatchondo & Leonardo Martinez, 2009. "Long-duration bonds and sovereign defaults," Working Paper, Federal Reserve Bank of Richmond 08-02, Federal Reserve Bank of Richmond.
  5. Eva Carceles Poveda & Arpad Abraham, 2009. "Tax Reform with Endogenous Borrowing Limits and Incomplete Asset Markets," 2009 Meeting Papers, Society for Economic Dynamics 1196, Society for Economic Dynamics.
  6. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2009. "On the cyclicality of the interest rate in emerging economy models: solution methods matter," Working Paper, Federal Reserve Bank of Richmond 09-13, Federal Reserve Bank of Richmond.
  7. Bulent Guler, 2010. "Innovations in Information Technology and the Mortgage Market," 2010 Meeting Papers, Society for Economic Dynamics 856, Society for Economic Dynamics.
  8. Ricardo Serrano-Padial & Lukasz Drozd, 2011. "Competitive Poaching in Unsecured Lending," 2011 Meeting Papers, Society for Economic Dynamics 1046, Society for Economic Dynamics.
  9. Juan Carlos Hatchondo & Cesar Sosa-Padilla & Leonardo Martinez, 2010. "Debt dilution, overborrowing, and sovereign default risk," 2010 Meeting Papers, Society for Economic Dynamics 481, Society for Economic Dynamics.

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