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The Role of Information in Consumer Debt and Bankruptcy

  • Juan M. Sanchez

    (University of Rochester)

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.

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Paper provided by Society for Economic Dynamics in its series 2008 Meeting Papers with number 523.

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Date of creation: 2008
Date of revision:
Handle: RePEc:red:sed008:523
Contact details of provider: Postal: Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA
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  1. Jeremy Greenwood & Juan M. Sánchez & Cheng Wang, 2010. "Financing development: the role of information costs," Working Papers 2010-024, Federal Reserve Bank of St. Louis.
  2. Igor Livshits & James MacGee & Michele Tertilt, 2006. "Accounting for the Rise in Consumer Bankruptcies," Discussion Papers 06-001, Stanford Institute for Economic Policy Research.
  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.
  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. Satyajit Chatterjee & Dean Corbae & Jose-Victor Rios-Rull, 2006. "Finite-Life, Private-Information Theory of Unsecured Debt," 2006 Meeting Papers 781, Society for Economic Dynamics.
  6. Michelle J. White, 2007. "Bankruptcy Reform and Credit Cards," NBER Working Papers 13265, National Bureau of Economic Research, Inc.
  7. Jaffee, Dwight M & Russell, Thomas, 1976. "Imperfect Information, Uncertainty, and Credit Rationing," The Quarterly Journal of Economics, MIT Press, vol. 90(4), pages 651-66, November.
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