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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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    Cited by:

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    2. Wu, Wei-Hwa, 2021. "Extendible stock loan," The North American Journal of Economics and Finance, Elsevier, vol. 58(C).
    3. Kim, Jiseob, 2019. "How foreclosure delays impact mortgage defaults and mortgage modifications," Journal of Macroeconomics, Elsevier, vol. 59(C), pages 18-37.

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