Optimal Personal Bankruptcy Design: A Mirrlees Approach

FRB Richmond Working Paper No. 08-05

44 Pages Posted: 11 Dec 2012

See all articles by Borys Grochulski

Borys Grochulski

Federal Reserve Banks - Federal Reserve Bank of Richmond

Date Written: September 1, 2008

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, unsecured credit, moral hazard

Suggested Citation

Grochulski, Borys, Optimal Personal Bankruptcy Design: A Mirrlees Approach (September 1, 2008). FRB Richmond Working Paper No. 08-05, Available at SSRN: https://ssrn.com/abstract=2187906 or http://dx.doi.org/10.2139/ssrn.2187906

Borys Grochulski (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Richmond ( email )

P.O. Box 27622
Richmond, VA 23261
United States

HOME PAGE: http://www.richmondfed.org/research/economists/bios/grochulski_bio.cfm

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