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German Working Papers in Law and Economics
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Volume 2001

AUTHOR:
Charles Grant

TITLE:
Consumer Bankruptcy Law, Credit Contraints and Insurance: Some Empirics

SUGGESTED CITATION:
Charles Grant (2001) "Consumer Bankruptcy Law, Credit Contraints and Insurance: Some Empirics", German Working Papers in Law and Economics: Vol. 2001: Article 3.
http://www.bepress.com/gwp/default/vol2001/iss1/art3


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ABSTRACT:

Bankruptcy (defaulting on one’s debts) acts as insurance if the decision to default is negatively correlated with income shocks. However, whether bankruptcy provides insurance depends on the bankruptcy rules (the punishment for default) that is enforced. Bankruptcy rules can instead cause the consumer to be credit constrained. If debts are not fully enforceable, a rational lender may limit how much debt any borrowers are allowed to hold. This limit increases as the punishment for defaulting increases. The US provides a natural test of the theory since rules about which assets may be kept by the debtor, the state exemptions, when filing for bankruptcy differ dramat-ically across the different states. Regressions show that increasing the level of these exemptions causes less debt to be held by consumers. The paper also tests the theory more indirectly by regressing changes in the level, and in the variance, of consumption, which suggests that bankruptcy provides insurance.




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