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Bankruptcy and delinquency in a model of unsecured debt

  • Athreya, Kartik

    ()

    (Federal Reserve Bank of Richmond,)

  • Sánchez, Juan M.

    ()

    (Federal Reserve Bank of St. Louis)

  • Tam, Xuan S.

    ()

    (City University of Hong Kong)

  • Young, Eric R.

    ()

    (University of Virginia)

The two channels of default on unsecured consumer debt are (i) bankruptcy, which legally grants partial or complete removal of unsecured debt under certain circumstances, and (ii) delinquency, which is informal default via nonpayment. In the United States, both channels are used routinely. This paper introduces a model of unsecured consumer credit in the presence of both bankruptcy and delinquency. Our model yields three new findings: First, with respect to the choice between bankruptcy and delinquency, labor income shocks matter. Specifically, we find delinquency is readily used by borrowers with the worst labor market outcomes, even those with relatively minor levels of debt. In contrast, bankruptcy is used by households with relatively high debts, but whose long-run earnings prospects are high enough to make interest rate penalties from delinquency too large. Second, financial distress is persistent: households in poor financial conditions stay in that state for several quarters. Third, in broad terms, bankruptcy and delinquency are “substitutes,” with bankruptcy increasing as delinquency costs rise.

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File URL: http://research.stlouisfed.org/wp/2012/2012-042.pdf
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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2012-042.

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Length: 52 pages
Date of creation: 2012
Date of revision: 30 Jan 2014
Handle: RePEc:fip:fedlwp:2012-042
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  1. Ulf von Lilienfeld-Toal & Dilip Mookherjee, 2010. "The Political Economy of Debt Bondage," American Economic Journal: Microeconomics, American Economic Association, vol. 2(3), pages 44-84, August.
  2. Satyajit Chatterjee & Burcu Eyigungor, 2010. "Maturity, indebtedness, and default risk," Working Papers 10-12, Federal Reserve Bank of Philadelphia.
  3. Julio Davila & Jay H. Hong & Per Krusell & José-Victor Rios Rull, 2005. "Constrained efficiency in the neoclassical growth model with uninsurable idiosyncratic shocks," Cahiers de la Maison des Sciences Economiques b05066, Université Panthéon-Sorbonne (Paris 1).
  4. Hatchondo, Juan Carlos & Martinez, Leonardo, 2009. "Long-duration bonds and sovereign defaults," Journal of International Economics, Elsevier, vol. 79(1), pages 117-125, September.
  5. Leonardo Martinez & Juan Carlos Hatchondo & Juan M. Sanchez, 2012. "Mortgage Defaults," IMF Working Papers 12/26, International Monetary Fund.
  6. Kartik B. Athreya & Xuan S. Tam & Eric R. Young, 2009. "Are harsh penalties for default really better?," Working Paper 09-11, Federal Reserve Bank of Richmond.
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