IDEAS home Printed from https://ideas.repec.org/p/fip/fedrwp/08-05.html
   My bibliography  Save this paper

Optimal personal bankruptcy design : A Mirrlees approach

Author

Listed:
  • Borys Grochulski

Abstract

In this paper, we develop a normative theory of unsecured consumer credit and personal bankruptcy based on the optimal trade-off between incentives and insurance. First, in order to characterize this trade-off, we solve a dynamic moral hazard problem in which agents' private effort decisions influence the life-cycle profiles of their earnings. We then show how the optimal allocation of individual effort and consumption can be implemented in a market equilibrium in which (i) agents and intermediaries repeatedly trade in secured and unsecured debt instruments, and (ii) agents obtain (restricted) discharge of their unsecured debts in bankruptcy. The structure of this equilibrium and the associated restrictions on debt discharge closely match the main qualitative features of personal credit markets and bankruptcy law that actually exist in the United States.

Suggested Citation

  • Borys Grochulski, 2008. "Optimal personal bankruptcy design : A Mirrlees approach," Working Paper 08-05, Federal Reserve Bank of Richmond.
    • Handle: RePEc:fip:fedrwp:08-05
    as

    Download full text from publisher

    File URL: https://www.richmondfed.org/publications/research/working_papers/2008/wp_08-5.cfm
    Download Restriction: no
    File URL: https://www.richmondfed.org/-/media/RichmondFedOrg/publications/research/working_papers/2008/pdf/wp08-5.pdf
    File Function: Full text
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Pagano, Marco & Jappelli, Tullio, 1993. "Information Sharing in Credit Markets," Journal of Finance, American Finance Association, vol. 48(5), pages 1693-1718, December.
    2. Athreya, Kartik B. & Simpson, Nicole B., 2006. "Unsecured debt with public insurance: From bad to worse," Journal of Monetary Economics, Elsevier, vol. 53(4), pages 797-825, May.
    3. Christopher Phelan & Robert M. Townsend, 1991. "Computing Multi-Period, Information-Constrained Optima," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 58(5), pages 853-881.
    4. Reint Gropp & John Karl Scholz & Michelle J. White, 1997. "Personal Bankruptcy and Credit Supply and Demand," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 112(1), pages 217-251.
    5. Irina A. Telyukova, 2013. "Household Need for Liquidity and the Credit Card Debt Puzzle," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 80(3), pages 1148-1177.
    6. Narayana R. Kocherlakota, 2005. "Zero Expected Wealth Taxes: A Mirrlees Approach to Dynamic Optimal Taxation," Econometrica, Econometric Society, vol. 73(5), pages 1587-1621, September.
    7. Alberto Bisin & Adriano Rampini, 2006. "Exclusive contracts and the institution of bankruptcy," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 27(2), pages 277-304, January.
    8. David B. Gross & Nicholas S. Souleles, 2002. "Do Liquidity Constraints and Interest Rates Matter for Consumer Behavior? Evidence from Credit Card Data," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 117(1), pages 149-185.
    9. Pradeep Dubey & John Geanakoplos & Martin Shubik, 2005. "Default and Punishment in General Equilibrium," Econometrica, Econometric Society, vol. 73(1), pages 1-37, January.
    10. Kehoe, Timothy J & Levine, David K, 2001. "Liquidity Constrained Markets versus Debt Constrained Markets," Econometrica, Econometric Society, vol. 69(3), pages 575-598, May.
    11. Bizer, David S. & DeMarzo, Peter M., 1999. "Optimal Incentive Contracts When Agents Can Save, Borrow, and Default," Journal of Financial Intermediation, Elsevier, vol. 8(4), pages 241-269, October.
    12. Li, Wenli & Sarte, Pierre-Daniel, 2006. "U.S. consumer bankruptcy choice: The importance of general equilibrium effects," Journal of Monetary Economics, Elsevier, vol. 53(3), pages 613-631, April.
    13. Igor Livshits & James MacGee & Michèle Tertilt, 2007. "Consumer Bankruptcy: A Fresh Start," American Economic Review, American Economic Association, vol. 97(1), pages 402-418, March.
    14. Andrew Atkeson & Robert E. Lucas, 1992. "On Efficient Distribution With Private Information," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 59(3), pages 427-453.
    15. Atkeson Andrew & Lucas Jr. , Robert E., 1995. "Efficiency and Equality in a Simple Model of Efficient Unemployment Insurance," Journal of Economic Theory, Elsevier, vol. 66(1), pages 64-88, June.
    16. Irina A. Telyukova & Randall Wright, 2008. "A Model of Money and Credit, with Application to the Credit Card Debt Puzzle," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 75(2), pages 629-647.
    17. Stefania Albanesi & Christopher Sleet, 2006. "Dynamic Optimal Taxation with Private Information," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 73(1), pages 1-30.
    18. Michelle J. White, 2007. "Bankruptcy Reform and Credit Cards," Journal of Economic Perspectives, American Economic Association, vol. 21(4), pages 175-200, Fall.
    19. Gian Luca Clementi & Hugo A. Hopenhayn, 2006. "A Theory of Financing Constraints and Firm Dynamics," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 121(1), pages 229-265.
    20. Prescott, Edward C & Townsend, Robert M, 1984. "Pareto Optima and Competitive Equilibria with Adverse Selection and Moral Hazard," Econometrica, Econometric Society, vol. 52(1), pages 21-45, January.
    21. 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.
    22. Timothy J. Kehoe & David K. Levine, 1993. "Debt-Constrained Asset Markets," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 60(4), pages 865-888.
    23. Fernandes, Ana & Phelan, Christopher, 2000. "A Recursive Formulation for Repeated Agency with History Dependence," Journal of Economic Theory, Elsevier, vol. 91(2), pages 223-247, April.
    24. Timothy J. Kehoe & David K. Levine, 2008. "Bankruptcy and Collateral in Debt Constrained Markets," Chapters, in: Roger E.A. Farmer (ed.), Macroeconomics in the Small and the Large, chapter 5, Edward Elgar Publishing.
    25. Mikhail Golosov & Aleh Tsyvinski, 2006. "Designing Optimal Disability Insurance: A Case for Asset Testing," Journal of Political Economy, University of Chicago Press, vol. 114(2), pages 257-279, April.
    26. Mikhail Golosov & Aleh Tsyvinski, 2007. "Optimal Taxation with Endogenous Insurance Markets," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 122(2), pages 487-534.
    27. Giuseppe Bertola & Richard Disney & Charles Grant (ed.), 2006. "The Economics of Consumer Credit," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262026015, April.
    28. Stephen E. Spear & Sanjay Srivastava, 1987. "On Repeated Moral Hazard with Discounting," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 54(4), pages 599-617.
    29. Fernando Alvarez & Urban J. Jermann, 2000. "Efficiency, Equilibrium, and Asset Pricing with Risk of Default," Econometrica, Econometric Society, vol. 68(4), pages 775-798, July.
    30. J. A. Mirrlees, 1971. "An Exploration in the Theory of Optimum Income Taxation," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 38(2), pages 175-208.
    31. PETER M. DeMARZO & YULIY SANNIKOV, 2006. "Optimal Security Design and Dynamic Capital Structure in a Continuous‐Time Agency Model," Journal of Finance, American Finance Association, vol. 61(6), pages 2681-2724, December.
    32. A. Rampini, Adriano, 2005. "Default and aggregate income," Journal of Economic Theory, Elsevier, vol. 122(2), pages 225-253, June.
    33. Kahn, Charles M. & Mookherjee, Dilip, 1995. "Market failure with moral hazard and side trading," Journal of Public Economics, Elsevier, vol. 58(2), pages 159-184, October.
    34. Michelle J. White, 2007. "Bankruptcy Reform and Credit Cards," NBER Working Papers 13265, National Bureau of Economic Research, Inc.
    35. Rogerson, William P, 1985. "Repeated Moral Hazard," Econometrica, Econometric Society, vol. 53(1), pages 69-76, January.
    36. Townsend, Robert M., 1988. "Information constrained insurance : The revelation principle extended," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 411-450.
    37. Athreya, Kartik B., 2002. "Welfare implications of the Bankruptcy Reform Act of 1999," Journal of Monetary Economics, Elsevier, vol. 49(8), pages 1567-1595, November.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Athreya, Kartik & Tam, Xuan S. & Young, Eric R., 2009. "Unsecured credit markets are not insurance markets," Journal of Monetary Economics, Elsevier, vol. 56(1), pages 83-103, January.
    2. Laurence Ales & Maziero Pricila, "undated". "Accounting for Private Information," GSIA Working Papers 2010-E58, Carnegie Mellon University, Tepper School of Business.
    3. Casey B. Mulligan, 2010. "Foreclosures, Enforcement, and Collections under the Federal Mortgage Modification Guidelines," NBER Working Papers 15777, National Bureau of Economic Research, Inc.
    4. Casey B. Mulligan, 2009. "Means-Tested Mortgage Modification: Homes Saved or Income Destroyed?," NBER Working Papers 15281, National Bureau of Economic Research, Inc.
    5. Kartik B. Athreya & Xuan S. Tam & Eric Young, 2009. "Are harsh penalties for default really better?," Working Paper 09-11, Federal Reserve Bank of Richmond.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Gordon, Grey, 2017. "Optimal bankruptcy code: A fresh start for some," Journal of Economic Dynamics and Control, Elsevier, vol. 85(C), pages 123-149.
    2. Golosov, M. & Tsyvinski, A. & Werquin, N., 2016. "Recursive Contracts and Endogenously Incomplete Markets," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.), Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 725-841, Elsevier.
    3. Igor Livshits, 2015. "Recent Developments In Consumer Credit And Default Literature," Journal of Economic Surveys, Wiley Blackwell, vol. 29(4), pages 594-613, September.
    4. Mateos-Planas, Xavier & Seccia, Giulio, 2006. "Welfare implications of endogenous credit limits with bankruptcy," Journal of Economic Dynamics and Control, Elsevier, vol. 30(11), pages 2081-2115, November.
    5. Laurence Ales & Maziero Pricila, "undated". "Accounting for Private Information," GSIA Working Papers 2010-E58, Carnegie Mellon University, Tepper School of Business.
    6. Krueger, Dirk & Perri, Fabrizio, 2011. "Public versus private risk sharing," Journal of Economic Theory, Elsevier, vol. 146(3), pages 920-956, May.
    7. Acemoglu, Daron & Golosov, Mikhail & Tsyvinski, Aleh, 2008. "Markets versus governments," Journal of Monetary Economics, Elsevier, vol. 55(1), pages 159-189, January.
    8. Roozbeh Hosseini & Larry E. Jones & Ali Shourideh, 2009. "Risk Sharing, Inequality and Fertility," NBER Working Papers 15111, National Bureau of Economic Research, Inc.
    9. Eduardo Dávila, 2020. "Using Elasticities to Derive Optimal Bankruptcy Exemptions," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 87(2), pages 870-913.
    10. Mikhail Golosov & Maxim Troshkin & Aleh Tsyvinski, 2011. "Optimal Taxation: Merging Micro and Macro Approaches," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 147-174, August.
    11. Koehne, Sebastian & Kuhn, Moritz, 2015. "Optimal taxation in a habit formation economy," Journal of Public Economics, Elsevier, vol. 122(C), pages 31-39.
    12. J. C. Parra & M. Huggett, 2005. "Quantifying the Inefficiency of the US Social Security System," Computing in Economics and Finance 2005 70, Society for Computational Economics.
    13. S. Viswanathan & Adriano A. Rampini, 2008. "Collateral, Financial Intermediation, and the Distribution of Debt Capacity," 2008 Meeting Papers 116, Society for Economic Dynamics.
    14. Radim Bohacek, 2000. "Capital Accumulation in an Economy with Heterogeneous Agents and Moral Hazard," CERGE-EI Working Papers wp165, The Center for Economic Research and Graduate Education - Economics Institute, Prague.
    15. Mankart, Jochen, 2014. "The (Un-) importance of Chapter 7 wealth exemption levels," Journal of Economic Dynamics and Control, Elsevier, vol. 38(C), pages 1-16.
    16. Pavan, Marina, 2008. "Consumer durables and risky borrowing: The effects of bankruptcy protection," Journal of Monetary Economics, Elsevier, vol. 55(8), pages 1441-1456, November.
    17. Stefania Albanesi, 2006. "optimal taxation of entrepreneurial capital with private information," 2006 Meeting Papers 310, Society for Economic Dynamics.
    18. YiLi Chien & JunSang Lee, 2006. "Optimal Capital Taxation under Limited Commitment," 2006 Meeting Papers 430, Society for Economic Dynamics.
    19. Noah Williams, 2011. "Persistent Private Information," Econometrica, Econometric Society, vol. 79(4), pages 1233-1275, July.
    20. Grochulski, Borys & Piskorski, Tomasz, 2010. "Risky human capital and deferred capital income taxation," Journal of Economic Theory, Elsevier, vol. 145(3), pages 908-943, May.

    More about this item

    Keywords

    Bankruptcy; Credit;

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:fip:fedrwp:08-05. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Christian Pascasio (email available below). General contact details of provider: https://edirc.repec.org/data/frbrius.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.