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On the welfare implications of restricting bankruptcy information

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  • Chen, Daphne
  • Corbae, Dean

Abstract

The Fair Credit Reporting Act (FCRA) dictates that adverse events such as a Chapter 7 bankruptcy filing must be removed from an individual's credit record after 10 years. The intent of the law is to provide partial consumption insurance by giving an individual a fresh start. However, the law obviously weakens incentives not to default, which can result in higher interest rates that in turn reduce intertemporal insurance. Because of this tradeoff, it is unclear how long is the optimal length of time that an adverse event remains on an individual's credit record. In this paper we assess the welfare consequences of varying the length of time that adverse events can be on one's credit record. We calibrate the model to US data where the exclusion parameter is set to be 10 years on average. Then we run a counterfactual to find the length that maximizes ex-post economywide welfare using a consumption equivalent measure. The model predicts agents prefer to remove the bankruptcy flag after one year, though the gains are small.

Suggested Citation

  • Chen, Daphne & Corbae, Dean, 2011. "On the welfare implications of restricting bankruptcy information," Journal of Macroeconomics, Elsevier, vol. 33(1), pages 4-13, March.
  • Handle: RePEc:eee:jmacro:v:33:y:2011:i:1:p:4-13
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    References listed on IDEAS

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    1. Chatterjee, Satyajit & Corbae, Dean & Ríos-Rull, José-Víctor, 2008. "A finite-life private-information theory of unsecured consumer debt," Journal of Economic Theory, Elsevier, vol. 142(1), pages 149-177, September.
    2. Tony Smith & M. Fatih Guvenen, 2007. "Inferring Labor Income Risk from Economic Choices: An Indirect Inference Approach," 2007 Meeting Papers 1024, Society for Economic Dynamics.
    3. Igor Livshits & James MacGee & Michèle Tertilt, 2010. "Accounting for the Rise in Consumer Bankruptcies," American Economic Journal: Macroeconomics, American Economic Association, vol. 2(2), pages 165-193, April.
    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. Igor Livshits & James MacGee & Michèle Tertilt, 2007. "Consumer Bankruptcy: A Fresh Start," American Economic Review, American Economic Association, vol. 97(1), pages 402-418, March.
    6. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, vol. 20(2), pages 177-181.
    7. Bulow, Jeremy & Rogoff, Kenneth, 1989. "Sovereign Debt: Is to Forgive to Forget?," American Economic Review, American Economic Association, vol. 79(1), pages 43-50, March.
    8. S. Rao Aiyagari, 1994. "Uninsured Idiosyncratic Risk and Aggregate Saving," The Quarterly Journal of Economics, Oxford University Press, vol. 109(3), pages 659-684.
    9. David K. Musto, 2004. "What Happens When Information Leaves a Market? Evidence from Postbankruptcy Consumers," The Journal of Business, University of Chicago Press, vol. 77(4), pages 725-748, October.
    10. Kartik B. Athreya & Hubert P. Janicki, 2006. "Credit exclusion in quantitative models of bankruptcy: does it matter?," Economic Quarterly, Federal Reserve Bank of Richmond, issue Win, pages 17-49.
    11. Athreya, Kartik B., 2002. "Welfare implications of the Bankruptcy Reform Act of 1999," Journal of Monetary Economics, Elsevier, vol. 49(8), pages 1567-1595, November.
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    Cited by:

    1. Gordon, Grey, 2017. "Optimal bankruptcy code: A fresh start for some," Journal of Economic Dynamics and Control, Elsevier, vol. 85(C), pages 123-149.

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    Keywords

    Bankruptcy regulation Welfare;

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