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Economic Quarterly

Winter 2006

Credit Exclusion in Quantitative Models of Bankruptcy: Does It Matter?

Kartik B. Athreya and Hubert P. Janicki

This article takes a first step in evaluating a commonly used assumption in recent quantitative analyses of unsecured household borrowing--the temporary exclusion of defaulting borrowers from credit markets. Exclusion from credit markets is an attractive modeling device for tractably modeling default on both consumer debt and sovereign debt. Nonetheless, such exclusion is not easily supported and deserves more justification than has been provided in the available literature. In particular, a key problem in choosing to punish default ex post by exclusion is that lenders and borrowers forgo opportunities for mutually beneficial trade that exist after default. In this paper we perform a set of experiments in a standard model of bankruptcy to clarify the circumstances in which exclusion is, or is not, likely to be an innocuous simplification. We then examine the possibility that changes to exclusion-related penalties occurring in the 1990s were important for the subsequent rise of household debt and personal bankruptcy.

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