A Quantitative Theory of Unsecured Consumer Credit with Risk of Default

June 2007

WP 07-16 – The authors study, theoretically and quantitatively, the general equilibrium of an economy in which households smooth consumption by means of both a riskless asset and unsecured loans with the option to default.

Supersedes Working Paper 05-18 – A Quantitative Theory of Unsecured Consumer Credit with Risk of Default

The default option resembles a bankruptcy filing under Chapter 7 of the U.S. Bankruptcy Code. Competitive financial intermediaries offer a menu of loan sizes and interest rates wherein each loan makes zero profits. They prove the existence of a steady-state equilibrium and characterize the circumstances under which a household defaults on its loans. They show that their model accounts for the main statistics regarding bankruptcy and unsecured credit while matching key macroeconomic aggregates and the earnings and wealth distributions. They use this model to address the implications of a recent policy change that introduces a form of "means-testing" for households contemplating a Chapter 7 bankruptcy filing. They find that this policy change yields large welfare gains.

Revision forthcoming in Econometrica.

View the Full Working Paper