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Formal vs. Informal Default in Consumer Credit

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  • Xavier Mateos-Planas

    (Queen Mary University of London)

  • David Benjamin

    (SUNY Buffalo)

Abstract

This paper studies informal default in consumer credit as the start of a process of negotiation with the lender. We consider an economy with uninsurable individual risk where households in debt have also the option of declaring formal bankruptcy. In a calibrated version of the model, informal defaulters are notably wealthier, have lower income, and hold more debt than formal defaulters, an implication consistent with the evidence. Quick settlements are achieved often, with limited discounts. Protracted negotiations feature individuals disaving before they reach agreement or declare bankruptcy. Allowing for negotiations raises default rates but substantially improves welfare as it provides greater insurance opportunities. Thus lowering the cost of informal default, as opposed to that of formal default, raises welfare and dampens consumption volatility. A tighter exemption improves welfare as the bargaining option mitigates the adverse effect on insurance via formal bankruptcy. Attempts at limiting collection outside bankruptcy reduce the incidence of bankruptcy but lower overall welfare.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 144.

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Date of creation: 2012
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Handle: RePEc:red:sed012:144

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References

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  1. Greg Kaplan & Giovanni L. Violante, 2009. "How Much Consumption Insurance Beyond Self-Insurance?," NBER Working Papers 15553, National Bureau of Economic Research, Inc.
  2. Javier Díaz-Giménez & Andrew Glover & José-Víctor Ríos-Rull, 2011. "Facts on the distributions of earnings, income, and wealth in the United States: 2007 update," Quarterly Review, Federal Reserve Bank of Minneapolis.
  3. David Benjamin & Mark L. J. Wright, 2009. "Recovery Before Redemption: A Theory Of Delays In Sovereign Debt Renegotiations," CAMA Working Papers 2009-15, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  4. 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.
  5. Hintermaier, Thomas & Koeniger, Winfried, 2011. "Debt Portfolios," CEPR Discussion Papers 8359, C.E.P.R. Discussion Papers.
  6. Mateos-Planas, Xavier, 2009. "A model of credit limits and bankruptcy with applications to welfare and indebtedness," Discussion Paper Series In Economics And Econometrics 0910, Economics Division, School of Social Sciences, University of Southampton.
  7. Jose-Victor Rios-Rull & Xavier Mateos-Planas, 2009. "Credit Lines," 2009 Meeting Papers 894, Society for Economic Dynamics.
  8. repec:acb:camaaa:2009-15 is not listed on IDEAS
  9. Kartik Athreya, 2004. "Fresh start or head start? Uniform bankruptcy exemptions and welfare," Working Paper 03-03, Federal Reserve Bank of Richmond.
  10. Athreya, Kartik & Tam, Xuan S. & Young, Eric R., 2009. "Unsecured credit markets are not insurance markets," Journal of Monetary Economics, Elsevier, vol. 56(1), pages 83-103, January.
  11. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
  12. Satyajit Chatterjee, 2010. "An Equilibrium Model of the Timing of Bankruptcy Filings," 2010 Meeting Papers 1282, Society for Economic Dynamics.
  13. Pavan, Marina, 2008. "Consumer durables and risky borrowing: The effects of bankruptcy protection," Journal of Monetary Economics, Elsevier, vol. 55(8), pages 1441-1456, November.
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Cited by:
  1. Lukasz A. Drozd & Ricardo Serrano-Padial, 2013. "Modeling the credit card revolution: the role of debt collection and informal bankruptcy," Working Papers 13-12, Federal Reserve Bank of Philadelphia.
  2. Kyle F. Herkenhoff & Lee Ohanian, 2012. "Foreclosure delay and U.S. unemployment," Working Papers 2012-017, Federal Reserve Bank of St. Louis.
  3. Kyle F. Herkenhoff, 2012. "Informal unemployment insurance and labor market dynamics," Working Papers 2012-057, Federal Reserve Bank of St. Louis.
  4. Igor Livshits & Natalia Kovrijnykh, 2013. "Screening as a Unified Theory of Delinquency, Renegotiation and Bankruptcy," 2013 Meeting Papers 1014, Society for Economic Dynamics.
  5. Athreya, Kartik B. & Sanchez, Juan M. & Tam, Xuan S. & Young, Eric R., 2014. "Labor market upheaval, default regulations, and consumer debt," Working Papers 2014-2, Federal Reserve Bank of St. Louis.
  6. Xavier Mateos-Planas & Giulio Seccia, 2013. "Consumer Default with Complete Markets: Default-based Pricing and Finite Punishment," Working Papers 711, Queen Mary, University of London, School of Economics and Finance.

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