The Option Value of Consumer Bankruptcy: Can Uninsured Idiosyncratic Risk Explain Bankruptcy Patterns?

Abstract

This paper contributes to the literature on the causes of consumer bankruptcy. It presents the bankruptcy decision as an irreversible choice with an embedded real option. The principal empirical finding is that cross-sectional variances of economic factors, such as unemployment, are strong predictors of bankruptcy rates and consistent with the real options model. This supports evidence that individuals face increased uncertainty and indicates that uninsurable economic shocks are poorly characterized by local information. Finally, the paper concludes that policy discussions may be disproportionately focused on credit variables such as utilization rates and supply of credit rather than exposure to risk.