OUP accepted manuscript

2019 The Review of Economic Studies  
This paper characterizes the optimal bankruptcy exemption for risk averse borrowers who use unsecured contracts but have the possibility of defaulting. It provides a novel general formula -which holds in a wide variety of environments -for the optimal exemption as a function of a few observable sufficient statistics. Borrowers' leverage, the sensitivity of the equilibrium credit spread with respect to the level of bankruptcy exemption, the probability of default and the change in consumption by
more » ... e in consumption by bankrupt borrowers turn out to be the key determinants of the optimal bankruptcy exemption. When calibrated to US data, the optimal bankruptcy exemption implied by the model ($100,000) is slightly larger than the average exemption in the US ($70,000), but of the same order of magnitude. JEL numbers: G18, K35, G33
doi:10.1093/restud/rdz043 fatcat:yy27ibn5cngw7adwipvcbo2pe4