Munich Personal RePEc Archive

Information Technology and the Rise of Household Bankruptcy

N. Narajabad, Borghan (2010): Information Technology and the Rise of Household Bankruptcy.

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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 study an adverse selection environment where borrowers are heterogeneous with respect to their cost of default. Creditors 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 creditors' 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 higher credit limits for borrowers with high default costs, and lowers credit limits of borrowers with low costs of default. Hence a more informative signal allows those with high default costs to borrow more, making them more likely to default, while decreasing borrowing and default by those with low default costs.

Using Simulated Method of Moments, I estimate the model parameters to match the increases in the average consumer credit card limit, the average unsecured consumer debt level and the spread of the credit limit distribution from 1992 to 1998 using the Survey of Consumer Finance's data. The model does well in matching the targeted moments and can account for one third to half of the increase in the number of bankruptcy filings from 1992 to 1998.

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