Consumer durables and risky borrowing: The effects of bankruptcy protection

There exist substantial differences in the generosity of bankruptcy protection across U.S. states. This paper exploits cross-state variation in exemption levels to assess the dual role of durable goods as informal collateral for unsecured debt and self-insurance against bad shocks to earnings. The generosity of bankruptcy protection is found to change both the incentives and the ability of households to accumulate durable wealth. The gains from a high level of insurance are reduced by the effect of tighter credit constraints, so that the net effects of a change in exemption are very small. A more generous bankruptcy regulation reduces net durable wealth in the first half of the life cycle. In addition, the optimal level of exemption is positive but low.