| In Chapter 1, I extend the recent precautionary savings models to allow for uncollaterized borrowing, default and interest rate risk. In case households choose to default: (i) their access to credit markets is restricted, (ii) lenders of funds may seize their financial assets above an exemption level, and up to the amount of outstanding debt, (iii) there is a “stigma effect,” or a decrease in current utility caused by the social embarrassment of declaring bankruptcy. I show that the decision to default is closely related to the shape of life cycle labor income profile. I identify the conditions under which it is optimal to make strategic borrowing (borrowing with the intent of default in the near future). In the model, agents wish to hold both positive financial assets and debt, even though the rate of interest on debt is higher than that on financial assets. The empirical evidence supports this finding. It arises because, in case consumers choose to default, credit card firms cannot seize all their assets.; In Chapter 2, I solve a model of the optimal credit card debt limit over the life-cycle. I model consumers' consumption and borrowing behaviour as in Chapter 1, but close the model by assuming a competitive market for credit card firms. I solve the problem of a social planner who chooses the credit card limit and the interest rate premium, taking into account consumers' optimal consumption, borrowing, and default decisions, so as to maximize the consumers' lifetime expected utility subject to the constraint that credit card firms break even on average. I find that the optimal credit limit is hump-shaped over life and the amount borrowed is decreasing over life. The lower credit limit late in life revents strategic-default. Default rates are highest early in life, and so is the interest rate premium on debt.; In Chapter 3 I, extend the precautionary saving models by explicitly modelling consumers' housing choices. The model allows for proportional transaction costs of changing houses and uncertainty in house prices. The results show that housing contributes to generate excess sensitivity of consumption relative to predictable changes in income. |
