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Optimal bankruptcy code: A fresh start for some

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  • Gordon, Grey

Abstract

What is the optimal consumer bankruptcy law? I answer this question using an incomplete markets life-cycle model with a planner who can choose state-contingent bankruptcy costs. I develop two main theoretical characterizations. First, whenever debt discharge is allowed, it should occur without cost. Second, bankruptcy should always be allowed for highly-indebted households. Quantitatively, the optimal policy can generate a welfare gain as large as 11.6%. However, attractive informal default, asymmetric information, and moral hazard can reduce the welfare gain to as little as 0.7%.

Suggested Citation

  • Gordon, Grey, 2017. "Optimal bankruptcy code: A fresh start for some," Journal of Economic Dynamics and Control, Elsevier, vol. 85(C), pages 123-149.
  • Handle: RePEc:eee:dyncon:v:85:y:2017:i:c:p:123-149
    DOI: 10.1016/j.jedc.2017.10.005
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    Keywords

    Bankruptcy; Life-cycle models; Incomplete markets;

    JEL classification:

    • D14 - Microeconomics - - Household Behavior - - - Household Saving; Personal Finance
    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • D91 - Microeconomics - - Micro-Based Behavioral Economics - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • K35 - Law and Economics - - Other Substantive Areas of Law - - - Personal Bankruptcy Law

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