An Analysis of Consumer Debt Restructuring Policies

Joao Cocco and Nuno Clara
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Joao Cocco: London Business School
Nuno Clara: London Business School

No 480, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: We solve a quantitative dynamic model of borrower behavior, whose income is subject to individual specific and aggregate shocks. Lenders provide loans competitively. Recessions are characterized by lower expected earnings growth and a higher likelihood of a large drop in earnings. The model generates procyclical credit demand and countercyclical default. We analyze alternative debt restructuring policies aimed at reducing default during recessions: (i) interest rate reduction; (ii) maturity extension; and (iii) refinancing. Outcomes are best for the maturity extension policy that allows borrowers to temporarily make interest-only payments on the loan. Not all borrowers exercise the option. The maturity extension policy leads to lower default rates, higher consumer welfare, and a smaller drop in consumption during recessions, without significantly increasing cash-flow risk for lenders.

Date: 2016
New Economics Papers: this item is included in nep-ban and nep-dge
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Citations: View citations in EconPapers (3)

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