Information Technology and the Rise of Household Bankruptcy∗

  • Borghan N. Narajabad
  • Published 2007

Abstract

Several studies attributed the rise of household bankruptcy in the past two decades to the decline of social stigma associated with default. Stigma explanations, however, cannot account for the increase of credit availability during this period. I try to explain both of these facts as a result of a more informative credit rating technology. I consider an adverse selection environment where borrowers are heterogeneous with respect to their cost of default. Lenders have access to a rating technology which provides an exogenous signal about borrowers’ default costs. Equilibrium contracts subject each borrower to a credit limit such that the lenders’ expected profit, conditional on the signal about the borrower’s default cost, is zero. As the exogenous signal becomes more informative, the credit market will provide a higher credit limit for borrowers with a high cost of default, and a lower limit for borrowers with a low cost of default. Hence a more informative signal allows those with a high cost of default to borrow more making them more likely to default, while decreasing borrowing and default by those who have a low cost of default. Using Simulated Method of Moments, I estimate the model to match data on the averages of available credit limits and debt as well as the increase in the spread of the credit limit distribution from the Survey of Consumer Finance 1992 and 1998. The model does well in matching the targeted moments and accounts for more than one third of the increase in the number of bankruptcy filings from 1992 to 1998.

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Cite this paper

@inproceedings{Narajabad2007InformationTA, title={Information Technology and the Rise of Household Bankruptcy∗}, author={Borghan N. Narajabad}, year={2007} }