Personal Bankruptcy Model Case Study

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3. PERSONAL BANKRUPTCY THEORY In this section, this paper deals with personal bankruptcy theory. It starts with an important theoretical issue - optimal bankruptcy policy and then move into the other theoretical issues - bankruptcy versus default, the option value of bankruptcy, bankruptcy and incentives for strategic behavior. 3.1 Optimal bankruptcy policy Optimal personal bankruptcy model is discussed in this section. This model takes into account the work incentives after bankruptcy, the trade-off due to loan availability and the objectives of ensuring against low consumptions. The conflict of interest among creditors is ignored in this model. It is assumed that a debtor has only one creditor, other alternate forms of consumption insurance such as welfare, unemployment compensation, and income tax is not considered in this model. Also, this model recognizes only one procedure of filing personal bankruptcy which…show more content…
This loan will be taken as an individual loan. During the repayment time, which is period two, the wealth is uncertain when this time come arrives. At this time, the debtor will consider his or her capabilities to repay the loan. If the debtors fail to repay the loans under all means, then they can consider filing for bankruptcy. After filing for bankruptcy, there is a wealth exemption X, which includes the states exemption for home equity and other commodities. Also, there is a fixed fraction m, which is exempted from future earnings. In this fraction, 0 < m ≤ 1. It is assumed that bankruptcy costs a fixed of S dollar. While in bankruptcy, the debtors’ debt is discharged but he or she must use all the non-exempt wealth to settle the debt they owe their

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