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Optimal Personal Bankruptcy Design: A Mirrlees Approach

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  • Borys Grochulski

    (Federal Reserve Bank of Richmond)

Abstract

In this paper, we propose a theory of unsecured consumer credit and personal bankruptcy based on the optimal trade-off between incentives and insurance. We solve a fairly standard dynamic moral hazard problem, in which agents’ private effort decisions influence the life-cycle profiles of their earnings. We then show how the optimal allocation of individual effort and consumption can be implemented in a market equilibrium in which agents and intermediaries repeatedly trade in secured and unsecured debt instruments, and agents obtain (restricted) discharge of their unsecured debts in bankruptcy. Surprisingly, the structure of this equilibrium and the associated restrictions on debt discharge closely match the main qualitative features of personal credit markets and bankruptcy law that actually exist in the United States.

Suggested Citation

  • Borys Grochulski, 2007. "Optimal Personal Bankruptcy Design: A Mirrlees Approach," 2007 Meeting Papers 1008, Society for Economic Dynamics.
  • Handle: RePEc:red:sed007:1008
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    References listed on IDEAS

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    Cited by:

    1. Athreya, Kartik & Tam, Xuan S. & Young, Eric R., 2009. "Unsecured credit markets are not insurance markets," Journal of Monetary Economics, Elsevier, pages 83-103.
    2. Laurence Ales & Maziero Pricila, "undated". "Accounting for Private Information," GSIA Working Papers 2010-E58, Carnegie Mellon University, Tepper School of Business.
    3. Casey B. Mulligan, 2010. "Foreclosures, Enforcement, and Collections under the Federal Mortgage Modification Guidelines," NBER Working Papers 15777, National Bureau of Economic Research, Inc.
    4. Casey B. Mulligan, 2009. "Means-Tested Mortgage Modification: Homes Saved or Income Destroyed?," NBER Working Papers 15281, National Bureau of Economic Research, Inc.
    5. 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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