Screening as a Unified Theory of Delinquency, Renegotiation, and Bankruptcy
28 Pages Posted: 9 Jan 2015
Date Written: November 1, 2013
We propose a parsimonious model with adverse selection where delinquency, renegotiation, and bankruptcy all occur in equilibrium as a result of a simple screening mechanism. A borrower has private information about her cost of bankruptcy, and a lender may use random contracts to screen different types of borrowers. In equilibrium, some borrowers choose not to repay, and thus become delinquent. The lender renegotiates with some delinquent borrowers. In the absence of renegotiation, delinquency leads to bankruptcy. We apply the model to analyze effects of a government intervention in debt restructuring. We show that a mortgage modification program aimed at limiting foreclosures that fails to take into account private debt restructuring may have the opposite effect from the one intended.
Keywords: Default, Delinquency, Bankruptcy, Renegotiation, Adverse Selection, Screening, Consumer Credit
JEL Classification: D14, D82, D86, G18, G21
Suggested Citation: Suggested Citation