Consumption, Debt and Portfolio Choice: Testing the Effect of Bankruptcy Law

Abstract

Consumer bankruptcy laws, which vary across states and over time, permit debtors to keep assets below a statutory exemption while debts are forgiven. High exemptions distort household portfolio decisions and tempt households to default on debts; but they also provide a crude form of consumption insurance. We combine information on state-level bankruptcy laws with the Consumer Expenditure Survey from 1984--1999. We find that higher exemptions are associated with (1) Higher bankruptcy rates, (2) Households that are more likely to simultaneously hold low-return liquid assets and owe high-cost unsecured debt, and (3) Better insurance for renters and worse insurance for homeowners.

Keywords: Bankruptcy law, household debt, portfolio puzzle

JEL Classification: H73, H31, K00, D1