Regulating Consumer Bankruptcy: A Theoretical Inquiry

Abstract:     
This paper uses a principal/agent framework to analyze consumer bankruptcy. The bankruptcy discharge partly insures risk averse borrowers against bad income realizations, but also reduces the borrower's incentive to avoid insolvency. Among our results are: (a) High bankruptcy exemptions increase bankruptcy insurance but at the cost of reducing the borrower's incentives to stay solvent; (b) Reaffirmations -- renegotiations -- have ambiguous efficiency effects in general, but the right to renegotiate is especially valuable for relatively poor persons; (c) Giving consumers the ex post choice regarding which bankruptcy chapter to use also provides more insurance but, by making bankruptcy softer on debtors, has poor incentive effects; (d) Serious consideration should be given to expanding the scope of consumers' ability to contract about bankruptcy because private contracts are better than regulations at making context sensitive tradeoffs between risk and incentives.

Number of Pages in PDF File: 58

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