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An Analysis of Consumer Debt Restructuring Policies

Author

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  • Joao Cocco

    (London Business School)

  • Nuno Clara

    (London Business School)

Abstract

We solve a quantitative dynamic model of borrower behavior, whose income is subject to individual specific and aggregate shocks. Lenders provide loans competitively. Recessions are characterized by lower expected earnings growth and a higher likelihood of a large drop in earnings. The model generates procyclical credit demand and countercyclical default. We analyze alternative debt restructuring policies aimed at reducing default during recessions: (i) interest rate reduction; (ii) maturity extension; and (iii) refinancing. Outcomes are best for the maturity extension policy that allows borrowers to temporarily make interest-only payments on the loan. Not all borrowers exercise the option. The maturity extension policy leads to lower default rates, higher consumer welfare, and a smaller drop in consumption during recessions, without significantly increasing cash-flow risk for lenders.

Suggested Citation

  • Joao Cocco & Nuno Clara, 2016. "An Analysis of Consumer Debt Restructuring Policies," 2016 Meeting Papers 480, Society for Economic Dynamics.
    • Handle: RePEc:red:sed016:480
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    References listed on IDEAS

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    1. An Analysis of Consumer Debt Restructuring Policies
      by Christian Zimmermann in NEP-DGE blog on 2016-08-26 20:52:24

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