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The Role of Information in Consumer Debt and Bankruptcy

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  • Juan M. Sanchez

    (University of Rochester)

Abstract

Consumer debt and bankruptcy are central issues today because of their explosive trends over the last 20 years in the U.S. economy. However, there is no convincing explanation for these facts. A drop in information costs, a potential cause, has not been evaluated mainly because there is no quantitative theory of consumer debt and bankruptcy where the cost of information plays an important role. This paper provides such a theory and quantifies how much of the rise in debt and bankruptcy can be attributed to the drop in information costs. In the model, lenders offer contracts specifying both interest rates and borrowing limits. In equilibrium, the contracts with low interest rates have tight borrowing limits, while those with high interest rates have loose borrowing limits. Despite being borrowing constrained, low-risk individuals prefer to borrow at the low interest rate. Conversely, high-risk individuals prefer to borrow more at higher interest rates. As the costs of information drop, it may be possible to explicitly condition loans on an individual’s risk. This allows previously borrowing constrained individuals to borrow more. As a result, there is also more bankruptcy because the benefits of filing bankruptcy are increasing in the debt size. The quantitative importance of this mechanism is then investigated by calibrating the model’s parameters to match moments for the years 1983 and 2004. The model can successfully match key data moments for both years varying only the cost of information and the income distribution. To quantify the effect of the drop in information costs over the last 20 years, two counterfactual economies are computed. The main finding is that the drop in information costs alone generates around 40% of the total rise in consumer bankruptcy.

Suggested Citation

  • Juan M. Sanchez, 2008. "The Role of Information in Consumer Debt and Bankruptcy," 2008 Meeting Papers 523, Society for Economic Dynamics.
  • Handle: RePEc:red:sed008:523
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    File URL: https://economicdynamics.org/meetpapers/2008/paper_523.pdf
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    References listed on IDEAS

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    1. Jaromir B. Nosal & Lukasz A. Drozd, 2008. "Competing for Customers: A Search Model of the Market for Unsecured Credit," 2008 Meeting Papers 274, Society for Economic Dynamics.
    2. Economides, Nicholas & Mitchell, Matthew & Skrzypacz, Andrzej, 2004. "Dynamic Oligopoly with Network Effects," Santa Cruz Department of Economics, Working Paper Series qt3z59c4p7, Department of Economics, UC Santa Cruz.
    3. Ábrahám, Árpád & Cárceles-Poveda, Eva, 2010. "Endogenous trading constraints with incomplete asset markets," Journal of Economic Theory, Elsevier, vol. 145(3), pages 974-1004, May.
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    Cited by:

    1. Kartik Athreya & Xuan S. Tam & Eric R. Young, 2012. "A Quantitative Theory of Information and Unsecured Credit," American Economic Journal: Macroeconomics, American Economic Association, vol. 4(3), pages 153-183, July.

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