Peer Financial Distress and Individual Leverage

Abstract

Using health shocks to identify financial distress situations, I document that peer distress leads to a decline in individual leverage and debt on average. Individual leverage declines by 5.7% and remains deflated for at least five years following peer distress. This decline occurs as individuals borrow less on the intensive margin, pay higher fractions of their debt and save more while their income remains unchanged following peer distress. As a result, individuals are less likely to default during the period following peer distress. The heterogeneity in responses highlight the role of changes in beliefs and preferences as the underlying mechanism.

Keywords: Leverage, Borrowing Decisions, Household Debt, Beliefs, Preferences

JEL Classification: D12, D14, D84, H31, R20