Working Paper

Bankruptcy and delinquency in a model of unsecured debt

Abstract: This paper documents and interprets two facts central to the dynamics of informal default or ?delinquency? on unsecured consumer debt. First, delinquency does not mean a persistent cessation of payment. In particular, we observe that for individuals 60 to 90 days late on payments, 85% make payments during the next quarter that allow them to avoid entering more severe delinquency. Second, many in delinquency (40%) have smaller debt obligations one quarter later. To understand these facts, we develop a theoretically and institutionally plausible model of debt delinquency and bankruptcy. Our model reproduces the dynamics of delinquency and suggests an interpretation of the data in which lenders frequently (in roughly 40% of cases) reset the terms for delinquent borrowers, typically involving partial debt forgiveness, rather than a blanket imposition of the ?penalty rates? most unsecured credit contracts specify.

Keywords: Consumer Debt; Bankruptcy; Default; Life cycle; Idiosyncratic risk;

JEL Classification: E43; E44; G33;

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Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2014-01-30

Number: 2012-042

Pages: 63 pages