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Consumer Bankruptcy Law, Credit Constraints and
Insurance: Some Empirics
Charles Grant12
University College London & European University Institute
April 26, 2002
1e-mail for correspndence: uctpcbg@ucl.ac.uk
2I would like to thank Gabriella Berloffa, Nick Bloom, Chris Carroll, Mario Padula, Luigi
Pistaferri, Ian Preston and and many other seminar participants whose comments have improved
this work immeasurably. An earlier version of this paper is available as CSEF working paper
number 40. Any remaining errors, of course, remain my own.
Abstract
Bankruptcy (defaulting on one’s debts) acts as insurance if it allows default in cases of
negative income shocks. However, whether bankruptcy provides insurance depends on the
bankruptcy rules (the punishment for default) that is enforced. Bankruptcy rules can instead
cause the consumer to be credit constrained. If debts are not fully enforceable, a rational
lender may limit how much debt any borrowers are allowed to hold. This limit increases as
the punishment for defaulting increases. The US provides a natural test of the theory since
rules about which assets may be kept by the debtor, the state exemptions, when filing for
bankruptcy differ dramatically across the different states. Regressions show that increasing
the level of these exemptions causes less debt to be held by consumers. The paper also tests
the theory more indirectly by regressing changes in the level, and in the standard deviation,
of consumption, which suggests that bankruptcy provides insurance.
1 Introduction
In recent years, a great deal of attention by consumpt