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Consumer Bankruptcy: A Fresh Start

  • Igor Livshits
  • James MacGee
  • Michèle Tertilt

Consumer bankruptcy provides partial insurance against bad luck, but, by driving up interest rates, makes life-cycle smoothing more difficult. We argue that to assess this trade-off one needs a quantitative model of consumer bankruptcy with three key features: life-cycle component, idiosyncratic earnings uncertainty, and expense uncertainty (exogenous negative shocks to household balance sheets). We find that transitory and persistent earnings shocks have very different implications for evaluating bankruptcy rules. More persistent shocks make the bankruptcy option more desirable. Larger transitory shocks have the opposite effect. Our findings suggest the current US bankruptcy system may be desirable for reasonable parameter values. (JEL D14, D91, K35)

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File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.97.1.402
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File URL: http://www.aeaweb.org/aer/data/mar07/20030636_data.zip
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Article provided by American Economic Association in its journal American Economic Review.

Volume (Year): 97 (2007)
Issue (Month): 1 (March)
Pages: 402-418

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Handle: RePEc:aea:aecrev:v:97:y:2007:i:1:p:402-418
Note: DOI: 10.1257/aer.97.1.402
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  19. Marina Pavan, 2003. "Consumer Durables and Risky Borrowing: the Effects of Bankruptcy Protection," Boston College Working Papers in Economics 573, Boston College Department of Economics, revised 01 May 2005.
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