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The optimal Chapter 7 exemption level in a life-cycle model with asset portfolios

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  • Mankart, Jochen

Abstract

I develop a heterogenous agent life-cycle model that examines the effects of the US personal bankruptcy law on bankruptcy filings and welfare. In addition to facing uncertainty over their labor income, agents also face wealth shocks that stem from unexpected changes in family composition or from unexpected medical expenses. I allow agents to borrow and save simultaneously. Some households borrow at high interest rates while simultaneously saving at low interest rate because of the option value of defaulting. This is consistent data on household assets. Under chapter 7 of the US bankruptcy law, consumers can keep all wealth up to an exemption level. I show that introducing exemption levels is of particular importance in the presence of wealth shocks. My quantitative evaluations show that changes in the exemption level have an impact only for very low exemption levels. Thus, ignoring them biases welfare results. But this impact fades out rather quickly. The reason is that almost no household is affected by medium to high exemption levels because those households who might default do not have much wealth. The welfare results of changes in the exemption level are rather small, less than 0.1% of annual consumption. In contrast to the earlier literature, but consistent with the data, I do not find a strong positive relationship between the exemption level and default rates. --

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Bibliographic Info

Paper provided by Verein für Socialpolitik / German Economic Association in its series Annual Conference 2011 (Frankfurt, Main): The Order of the World Economy - Lessons from the Crisis with number 48703.

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Date of creation: 2011
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Handle: RePEc:zbw:vfsc11:48703

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  1. 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.
  2. Jesus Fernández-Villaverde & Dirk Krueger, 2007. "Consumption over the Life Cycle: Facts from Consumer Expenditure Survey Data," The Review of Economics and Statistics, MIT Press, vol. 89(3), pages 552-565, August.
  3. Kartik Athreya, 2004. "Fresh start or head start? Uniform bankruptcy exemptions and welfare," Working Paper 03-03, Federal Reserve Bank of Richmond.
  4. Kjetil Storesletten & Chris Telmer & Amir Yaron, 1997. "Consumption and risk sharing over the life cycle," GSIA Working Papers 228, Carnegie Mellon University, Tepper School of Business.
  5. Pradeep Dubey & John Geanakoplos & Martin Shubik, 2001. "Default and Punishment in General Equilibrium," Cowles Foundation Discussion Papers 1304R5, Cowles Foundation for Research in Economics, Yale University, revised Mar 2004.
  6. Igor Livshits & James MacGee & Michele Tertilt, 2003. "Consumer bankruptcy: a fresh start," Working Papers 617, Federal Reserve Bank of Minneapolis.
  7. Mateos-Planas, Xavier & Seccia, Giulio, 2006. "Welfare implications of endogenous credit limits with bankruptcy," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2081-2115, November.
  8. Athreya, Kartik B., 2008. "Default, insurance, and debt over the life-cycle," Journal of Monetary Economics, Elsevier, vol. 55(4), pages 752-774, May.
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