A close up of bankruptcy paperwork, a calculator, a hand holding a pen, and a pair of glasses.

Working Paper

Personal Bankruptcy as a Real Option

Guozhong Zhu,
Slava Mikhed &
Barry Scholnick

November 2019

WP 19-46 - We provide a novel explanation to the longstanding puzzle of the "missing bankruptcy filings." Even though a household with a negative net worth will receive contemporaneous benefit from bankruptcy, there may be greater insurance value from delaying the filing.

Household bankruptcy is thus an American-style put option, which is not necessarily exercised even if the option is "in the money." Based on the value functions in the household's dynamic programming problem, we formulate the value of the bankruptcy option as well as the exercise price. We estimate a life-cycle model in which households choose the optimal time to exercise their bankruptcy option.

View the Full Working Paper