Credit markets and default in incomplete insurance economies

In recent years personal bankruptcy has become an important issue to consumers, creditors, and legislators alike. Over forty billion dollars of unsecured debt were discharged in 1998 by 1.44 million households. These losses have led legislators to propose a variety of changes in bankruptcy law, the most important of which is the Bankruptcy Reform Act of 1998(BA98). In the first chapter I develop a dynamic, stochastic, general equilibrium model of personal bankruptcy to investigate the role of idiosyncratic risk and bankruptcy rules in generating default behavior and interest rates for unsecured credit. The model is the first framework that allows both qualitative and quantitative general equilibrium analyses of personal bankruptcy in incomplete insurance settings. The model successfully produces plausible interest rates, but produces bankruptcy incidence in excess of the data. I use the model to evaluate the welfare consequences of the BA98 and find that agents usually prefer tough bankruptcy law, as it holds interest rates down, and keeps credit limits high. This provides preliminary support for BA98.; In the second chapter, I develop a model of personal bankruptcy with both secured and unsecured debt. I use the model to investigate the role of exemption rules for default behavior, consumption, welfare, and interest rates on both types of debt. I find that when exemptions are varied, bankruptcy incidence and unsecured interest rates respond modestly, but that welfare costs/benefits are consistently bounded above by 0.01% of average long-run benchmark consumption.; In the third chapter, we evaluate the welfare consequences of existing government loan guarantee and subsidy programs in an incomplete-market economy. In economies with incomplete markets “poor” agents have to wait until they accumulate enough wealth to finance their educations. Loan guarantees and subsidies can advance the timing of human capital acquisition and increase potential income mobility and welfare. We find that variations in the subsidy rates lead to small changes in allocations and welfare.