Consequences of Debt Forgiveness: Strategic Default Contagion and Lender Learning

58 Pages Posted: 14 Jan 2016 Last revised: 5 Dec 2018

Date Written: December 2018

Abstract

I use a unique data set of loans to small business owners to examine whether lenders face adverse consequences when they grant debt forgiveness to borrowers. I provide evidence consistent with borrowers communicating their debt forgiveness to other borrowers, who then more frequently strategically default on their own obligations. This strategic default contagion is economically large. When the lender doubles debt forgiveness, the default rate increases by 10.9% on average. Using an exogenous shock to the lender’s forgiveness policy, my findings suggest that as the lender learns about the extent of borrower communication the lender tightens its debt forgiveness policy to mitigate default contagion.

Keywords: Debt forgiveness, contracting, strategic default contagion, learning

JEL Classification: D10, D83, G21, M41

Suggested Citation

Perez Cavazos, Gerardo, Consequences of Debt Forgiveness: Strategic Default Contagion and Lender Learning (December 2018). Available at SSRN: https://ssrn.com/abstract=2714619 or http://dx.doi.org/10.2139/ssrn.2714619

Gerardo Perez Cavazos (Contact Author)

Harvard Business School ( email )

Soldiers Field Road
Morgan 270C
Boston, MA 02163
United States

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