Repetto, Andrea: Personal Bankruptcies and Individual Wealth Accumulation
World Conference Econometric Society, 2000, Seattle

Andrea Repetto, Universidad de Chile
Personal Bankruptcies and Individual Wealth Accumulation
Session: C-6-9  Sunday 13 August 2000  by Repetto, Andrea
This paper studies the interaction between the Personal Bankruptcy Code and the decision of individuals to accumulate wealth. According to the law, an individual who files for personal bankruptcy under Chapter 7 receives a discharge of most types of debts, and gives up wealth holdings that are above a specified exemption level. The protection of assets in the event of bankruptcy discourages wealth accumulation through several channels. First, for some states of nature, the exemption provides a floor to consumption, and therefore reduces the need to insure against negative income shocks. Second, assets held in excess of the exemption are taken away by creditors, and thus provide no benefits if the individual files. Finally, the Code reduces the expected cost of borrowing as debts are not necessarily repaid.
The empirical findings are consistent with the hypothesis that bankruptcy crowds out individual wealth accumulation. The estimated effect is large and up to 9% of actual median wealth holdings. An interesting finding is that the effect on individual wealth depends crucially on the type of assets that can be kept in bankruptcy. On one hand, exemptions not related to owner-occupied housing affect negatively net worth, mainly through their effect on financial wealth. On the other hand, homestead exemptions increase net worth, as they raise the amount of home equity individuals are willing to hold. Therefore, the bankruptcy law not only affects the level of wealth held by households, but also the composition of their portfolios.

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