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Assessing bankruptcy reform in a model with temptation and equilibrium default

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  • Makoto Nakajima

Abstract

A life-cycle model with equilibrium default in which consumers with and without temptation coexist is constructed to evaluate the 2005 bankruptcy law reform and other counterfactual reforms. The calibrated model indicates that the 2005 bankruptcy reform achieves its goal of reducing the number of bankruptcy filings, as seen in the data, but at the cost of loss in social welfare. The creditor-friendly reform provides borrowers with a stronger commitment to repay and thus yields lower default premia and better consumption smoothing. However, those who borrow and default due to temptation or unavoidable large expenditures suffer more under the reform due to higher costs or means-testing requirement. Moreover, those who borrow due to temptation suffer from overborrowing when the borrowing cost declines. The model indicates that the negative welfare effects dominate.

Suggested Citation

  • Makoto Nakajima, 2015. "Assessing bankruptcy reform in a model with temptation and equilibrium default," Working Papers 15-12, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:15-12
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    References listed on IDEAS

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    1. R. A. Pollak, 1968. "Consistent Planning," Review of Economic Studies, Oxford University Press, vol. 35(2), pages 201-208.
    2. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
    3. Juan Carlos Conesa & Sagiri Kitao & Dirk Krueger, 2009. "Taxing Capital? Not a Bad Idea after All!," American Economic Review, American Economic Association, vol. 99(1), pages 25-48, March.
    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. Jerome Adda & Russell W. Cooper, 2003. "Dynamic Economics: Quantitative Methods and Applications," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262012014, September.
    6. Attanasio, Orazio P & Weber, Guglielmo, 1995. "Is Consumption Growth Consistent with Intertemporal Optimization? Evidence from the Consumer Expenditure Survey," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1121-1157, December.
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    9. 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. Chatterjee, Satyajit & Eyigungor, Burcu, 2019. "Endogenous political turnover and fluctuations in sovereign default risk," Journal of International Economics, Elsevier, vol. 117(C), pages 37-50.
    2. Schlafmann, Kathrin, 2016. "Housing, Mortgages, and Self Control," CEPR Discussion Papers 11589, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

    Consumer bankruptcy; Debt; Default; Borrowing constraint; Temptation and self-control; Hyperbolic discounting; Heterogeneous agents; Incomplete markets;

    JEL classification:

    • 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
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • K35 - Law and Economics - - Other Substantive Areas of Law - - - Personal Bankruptcy Law

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