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Welfare implications of endogenous credit limits with bankruptcy

Welfare implications of endogenous credit limits with bankruptcy
Welfare implications of endogenous credit limits with bankruptcy
This paper studies the aggregate welfare consequences of changes in the prescribed penalty for personal bankruptcy and in social insurance policies when borrowing limits may respond to these changes. It uses a dynamic general equilibrium model of an exchange economy with incomplete markets and a continuum of agents. The borrowing constraint and the risk of default are endogenous, and the default penalty restricts an individual's access to the markets for a fixed period of time. The effect on the stationary equilibrium of an exogenous reduction of 1 and 2 years in this exclusion period is explored quantitatively. For comparison purposes, the same experiment is carried out under the assumption made in related studies that the borrowing limit is fixed. A small welfare loss follows in either case. In contrast, in a small open economy, welfare may increase substantially but only if the borrowing constraint is endogenous. Similar results follow from an exogenous change in social policy that reduces individual income variability.
borrowing constraints, incomplete markets, default, bankruptcy
0165-1889
2081-2115
Mateos-Planas, Xavier
444f69bb-2ab3-4f56-be17-3f286f7700da
Seccia, Giulio
5fb5c6bf-4289-4962-9682-d2decbb0c4ba
Mateos-Planas, Xavier
444f69bb-2ab3-4f56-be17-3f286f7700da
Seccia, Giulio
5fb5c6bf-4289-4962-9682-d2decbb0c4ba

Mateos-Planas, Xavier and Seccia, Giulio (2006) Welfare implications of endogenous credit limits with bankruptcy. Journal of Economic Dynamics and Control, 30 (11), 2081-2115. (doi:10.1016/j.jedc.2005.03.013).

Record type: Article

Abstract

This paper studies the aggregate welfare consequences of changes in the prescribed penalty for personal bankruptcy and in social insurance policies when borrowing limits may respond to these changes. It uses a dynamic general equilibrium model of an exchange economy with incomplete markets and a continuum of agents. The borrowing constraint and the risk of default are endogenous, and the default penalty restricts an individual's access to the markets for a fixed period of time. The effect on the stationary equilibrium of an exogenous reduction of 1 and 2 years in this exclusion period is explored quantitatively. For comparison purposes, the same experiment is carried out under the assumption made in related studies that the borrowing limit is fixed. A small welfare loss follows in either case. In contrast, in a small open economy, welfare may increase substantially but only if the borrowing constraint is endogenous. Similar results follow from an exogenous change in social policy that reduces individual income variability.

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More information

Published date: November 2006
Keywords: borrowing constraints, incomplete markets, default, bankruptcy

Identifiers

Local EPrints ID: 34875
URI: http://eprints.soton.ac.uk/id/eprint/34875
ISSN: 0165-1889
PURE UUID: 618774f6-19a0-4924-932c-c8702173f121

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Date deposited: 15 May 2006
Last modified: 15 Mar 2024 07:49

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Contributors

Author: Xavier Mateos-Planas
Author: Giulio Seccia

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