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Federal Reserve Bank of Philadelphia
Working Papers
Personal Bankruptcy as a Real Option
Guozhong Zhu
Vyacheslav Mikhed
Barry Scholnick

We provide a novel explanation to the longstanding puzzle of the “missing bankruptcy filings.” Even though a household with a negative net worth will receive contemporaneous benefit from bankruptcy, there may be greater insurance value from delaying the filing. 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.

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Guozhong Zhu & Vyacheslav Mikhed & Barry Scholnick, Personal Bankruptcy as a Real Option, Federal Reserve Bank of Philadelphia, Working Papers 19-46, 13 Nov 2019.
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Keywords: personal bankruptcy; option value; life cycle; secured and unsecured debts
DOI: 10.21799/frbp.wp.2019.46
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