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A Quantitative Theory of Unsecured Consumer Credit with Risk of Default

Listed author(s):
  • Satyajit Chatterjee

    (Federal Reserve Bank of Philadelphia)

  • Dean Corbae

    (University of Texas)

  • Makoto Nakajima

    (University of Pennsylvania)

  • Jose-Victor Rios-Rull

    (University of Pennsylvania and CAERP)

We study, theoretically and quantitatively, the equilibrium of an unsecured consumer credit industry where credit-suppliers take deposits at a given interest rate and offer loans to households via a menu of credit levels and associated interest rates. The loan industry is competitive, with free entry and zero costs, and borrowers have a default option that resembles, in process and consequence, a bankruptcy filing under Chapter 7 of the U.S. Bankruptcy Code. We show existence of a competitive equilibrium for such a loan industry and we characterize when and if a household defaults on its loans. We map the theory to the data in such a way as to account precisely for the quantitative properties of the facts regarding bankruptcy and unsecured credit (the volume of unsecured debt, the fraction of borrowers in the market, and the percentage of defaulters). We address the implications of a policy change that eliminates the Chapter 7 bankruptcy option for households with median or above-median income (a proposal with similar features is currently under consideration in Congress). We find that the welfare gain from this policy experiment is substantial, being equivalent to a lump-sum transfer payment of about one-quarter of average annual U.S. earnings.

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Paper provided by Centro de Altisimos Estudios Rios Perez (CAERP) in its series Centro de Alti­simos Estudios Ri­os Pe©rez(CAERP) with number 2.

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Length: 60 pages
Date of creation: Mar 2002
Handle: RePEc:cae:caerpp:2
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