Using Elasticities to Derive Optimal Bankruptcy Exemptions

Eduardo Davila

The Review of Economic Studies, 2020, vol. 87, issue 2, 870-913

Abstract: This article studies the optimal determination of bankruptcy exemptions for risk averse borrowers who use unsecured contracts but have the possibility of defaulting. In a large class of economies, knowledge of four variables is sufficient to determine whether a bankruptcy exemption level is optimal or should be increased or decreased. These variables are 1. the composition of households’ liabilities, 2. the sensitivity of the credit supply schedule to exemption changes, 3. the probability of filing for bankruptcy with non-exempt assets, and 4. the value given by households to a marginal dollar in different states, which can be mapped to changes in households’ consumption. I recover empirical estimates of the sufficient statistics using U.S. data over the period 2008–16 and find that increasing exemption levels improves overall welfare, although there is substantial variation in estimated welfare gains across U.S. states and income quintiles.

Keywords: Bankruptcy; Default; Sufficient statistics; Unsecured credit; General equilibrium with incomplete markets (search for similar items in EconPapers)
JEL-codes: D14 D52 K35 (search for similar items in EconPapers)
Date: 2020
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