Abstract
Bankruptcy provides entrepreneurs with insurance against the financial consequences of failure at the cost of worsened credit conditions. Using a quantitative general equilibrium model of entrepreneurship, we show that the presence of secured credit in addition to unsecured credit substantially alters this trade-off. If secured credit is not available the optimal bankruptcy law is harsh since the negative effect dominates. If secured credit is available the optimal law is lenient since entrepreneurs rationed out of the unsecured credit market can still obtain secured credit, lowering the costs of worse credit conditions. We find significant welfare gains from reforming the law.
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