Debt Default and the Insurance of Labor Income Risk

53 Pages Posted: 15 Aug 2013

See all articles by Kartik Athreya

Kartik Athreya

Federal Reserve Banks - Federal Reserve Bank of Richmond

Xuan S. Tam

City University of Hong Kong

Eric R. Young

University of Virginia

Abstract

In this article, we evaluate in detail the role of debt forgiveness in altering the transmission of labor income risk in the absence of catastrophic out-of-pocket "expense shocks" used in the literature on consumer default. The experiments we present can be thought of as: "If we insure the out-of-pocket expenses that constitute expenditure shocks, is there still a role of debt relief as a form of insurance against 'pure labor income risk'?" We address this question by studying a range of specifications for households' attitudes toward the intra- and inter-temporal properties of income risk alone. Our main finding is that, absent expense shocks, the ability to default very generally hinders the ability of households to protect themselves against labor income risk. Our findings suggest the scope of shocks that debt forgiveness is providing insurance against may be limited, perhaps principally to relatively catastrophic outcomes.

Suggested Citation

Athreya, Kartik and Tam, Xuan S. and Young, Eric R., Debt Default and the Insurance of Labor Income Risk. FRB Economic Quarterly, Vol. 98, No. 4, Fourth Quarter 2012, pp. 255-307, Available at SSRN: https://ssrn.com/abstract=2310171

Kartik Athreya (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

Xuan S. Tam

City University of Hong Kong ( email )

83 Tat Chee Avenue
Kowloon
Hong Kong

Eric R. Young

University of Virginia ( email )

1400 University Ave
Charlottesville, VA 22903
United States

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