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Housing, Personal Bankruptcy, Entrepreneurship

Listed author(s):
  • Yaz Terajima
  • Cesaire Meh


    (MFA Bank of Canada)

Homestead exemption is defined as the level of home equity that a household declaring bankruptcy can keep. This exemption level varies across states in the United States. As entreprenurial activities are risky, small business owners value the insurance the bankruptcy law provides. In their empirical study, Fan and White (2003 find that a probability of homeowners running a business is 35\% higher if they live in the states with unlimited rather than low homestead exemptions. Moreover, Sullivan, Warren and Westbrook (1999) estimate that about 20\% of bankrupts had debts from a failed business. As this numbuer is higher than the fraction of households who own a small business, an unproportionally high fraction of small business owners declare bankruptcy. In this paper, we ask the following question. What are the effects of reducing homestead exemption on entrepreneurship activity, bankruptcy rate, homeownership and welfare? We build a general equilibrium model with uninsurable idiosyncratic risks, where the agents make entrepreneurial, housing and bankruptcy choices. In the model, house is defined as a good that people derive utility from, has frictions in buying and selling, people can borrow against, and the government has special regulations on. The model also features a distinction between unsecure debts and secure debts. The unsecure debts are subject to a waiver when declaring bankruptcy while the secure debts are collateralized by house and not waiverable. We calibrate the model to the US economy and study the effects of eliminating homestead exemption on entrepreneurship activity, bankruptcy rate, homeownership and welfare. Our preliminary findings suggest that, when homestead exemption is eliminated, there will be a decrease in entrepreneurial activity, a decrease in bankruptcy rate and a decrease in home equity but no change in homeownership rate.

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Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2005 with number 415.

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Date of creation: 11 Nov 2005
Handle: RePEc:sce:scecf5:415
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