Personal Bankruptcy as a Real Option

Mikhed, Vyacheslav; Scholnick, Barry; Zhu, Guozhong

doi:10.21799/frbp.wp.2019.46

Working Paper

Personal Bankruptcy as a Real Option

Abstract: We provide a novel explanation to the longstanding puzzle of the ?missing bankruptcy ?lings.? Even though a household with a negative net worth will receive contemporaneous bene?t from bankruptcy, there may be greater insurance value from delaying the ?ling. Household bankruptcy is thus an American-style put option, which is not necessarily exercised even if the option is \"in the money.\" Based on the value functions in the household?s dynamic programming problem, we formulate the value of the bankruptcy option as well as the exercise price. We estimate a life-cycle model in which households choose the optimal time to exercise their bankruptcy option.

Keywords: personal bankruptcy; option value; life cycle; secured and unsecured debts;

JEL Classification: E21; R21;

https://doi.org/10.21799/frbp.wp.2019.46