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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 agents with and without temptation coexist is constructed to evaluate the 2005 bankruptcy law reform. The calibrated model indicates that the 2005 reform reduces bankruptcies, as seen in the data, and improves welfare, as lower default premia allows better consumption smoothing. A counterfactual reform of changing income garnishment rate is also investigated. Interesting contrasting welfare effects between two types of agents emerge. Agents with temptation prefer a lower garnishment rate as tighter borrowing constraint prevents them from over-borrowing, while those without prefer better consumption smoothing enabled by a higher garnishment rate. (First draft: May 23, 2008)

Suggested Citation

  • Makoto Nakajima, 2016. "Assessing Bankruptcy Reform in a Model with Temptation and Equilibrium Default," Working Papers 16-21, Federal Reserve Bank of Philadelphia.
  • Handle: RePEc:fip:fedpwp:16-21
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    References listed on IDEAS

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    Cited by:

    1. Bechlioulis, Alexandros P. & Brissimis, Sophocles N., 2019. "Consumer debt non-payment and the borrowing constraint: Implications for consumer behavior," Journal of Banking & Finance, Elsevier, vol. 101(C), pages 161-172.

    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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