"Three essays on personal bankruptcy"

Abstract

This thesis presents three essays on the field of personal bankruptcy.  The research carried out is mostly, but not fully, theoretical in nature.  The first chapter develops a model of general equilibrium with default and asks, among other things, how the level of default penalties can affect the welfare of different agents in an economy, when do agents face binding borrowing limits, and why some agents are denied credit upon application.  In answer to these questions, it shows that there exists an intermediate range of Pareto optimal punishment levels where changes in the punishment level benefit one type of agent but harm another; outside this range, punishment levels can be changed to benefit all agents.  It also proves that the existence of default is a sufficient condition for the emergence of borrowing limits which are binding; asymmetric information is not necessary for this to occur.  Finally, it shows that some agents can be denied credit if default penalties are too low or too high.  The chapter then also asks whether a competitive market will select the socially optimal punishment level, and shows that this is not, in general, the case – welfare can be improved if default penalties are set by a social planner.  Finally, a numerical experiment is performed to evaluate the welfare effects of a change in the law which allows only low-income households to default on their debts.  The result shows the welfare effects of this will depend on the degree of agent heterogeneity; if the gap between rich agents and poor agents is not large, then this policy benefits all agents.  If however the gap between the rich and the poor is substantially large, then this policy will benefit those who save and rich agents who borrow, while harming poor agents who borrow.

The second chapter extends this model to a world consisting of many open economies from between which funds can be transferred without cost, and examines how default penalties are set endogenously by the governments of each region.  It then explores the implications of such endogenous punishment formation.  From a normative perspective, it asks whether the resulting non-cooperative Nash equilibrium is welfare-maximising.  We find that this is not in general the case, and that welfare can increase if governments set their punishment levels cooperatively.

Finally, the third chapter develops the model to include bankruptcy exemptions which resemble legislation in the US and examines how these should be set optimally in a partial equilibrium environment.

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