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Optimal personal bankruptcy design: A Mirrlees approach

Borys Grochulski

No 08-05, Working Paper from Federal Reserve Bank of Richmond

Abstract: In this paper, we develop a normative theory of unsecured consumer credit and personal bankruptcy based on the optimal trade-off between incentives and insurance. First, in order to characterize this trade-off, we solve a dynamic moral hazard problem in which agents' private effort decisions influence the life-cycle profiles of their earnings. We then show how the optimal allocation of individual effort and consumption can be implemented in a market equilibrium in which (i) agents and intermediaries repeatedly trade in secured and unsecured debt instruments, and (ii) agents obtain (restricted) discharge of their unsecured debts in bankruptcy. The structure of this equilibrium and the associated restrictions on debt discharge closely match the main qualitative features of personal credit markets and bankruptcy law that actually exist in the United States.

Keywords: Bankruptcy; Credit (search for similar items in EconPapers)
Date: 2008
New Economics Papers: this item is included in nep-cta and nep-fmk
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (5)

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