Assessing Bankruptcy Reform in a Model with Temptation and Equilibrium Default

47 Pages Posted: 10 Mar 2015

See all articles by Makoto Nakajima

Makoto Nakajima

Federal Reserve Bank of Philadelphia

Multiple version iconThere are 2 versions of this paper

Date Written: March 5, 2015


A life-cycle model with equilibrium default in which consumers with and without temptation coexist is constructed to evaluate the 2005 bankruptcy law reform and other counterfactual reforms. The calibrated model indicates that the 2005 bankruptcy reform achieves its goal of reducing the number of bankruptcy filings, as seen in the data, but at the cost of loss in social welfare. The creditor-friendly reform provides borrowers with a stronger commitment to repay and thus yields lower default premia and better consumption smoothing. However, those who borrow and default due to temptation or unavoidable large expenditures suffer more under the reform due to higher costs or means-testing requirement. Moreover, those who borrow due to temptation suffer from overborrowing when the borrowing cost declines. The model indicates that the negative welfare effects dominate.

Keywords: Consumer Bankruptcy, Debt, Default, Borrowing Constraint, Temptation and Self-Control, Hyperbolic Discounting, Heterogeneous Agents, Incomplete Markets

JEL Classification: D91, E21, E44, G18, K35

Suggested Citation

Nakajima, Makoto, Assessing Bankruptcy Reform in a Model with Temptation and Equilibrium Default (March 5, 2015). FRB of Philadelphia Working Paper No. 15-12, Available at SSRN: or

Makoto Nakajima (Contact Author)

Federal Reserve Bank of Philadelphia ( email )

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Philadelphia, PA 19106-1574
United States

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