The optimal Chapter 7 exemption level in a life-cycle model with asset portfolios

I develop a heterogenous agent life-cycle model that examines the effects of the US personal bankruptcy law on bankruptcy filings and welfare. In addition to facing uncertainty over their labor income, agents also face wealth shocks that stem from unexpected changes in family composition or from unexpected medical expenses. I allow agents to borrow and save simultaneously. Some households borrow at high interest rates while simultaneously saving at low interest rate because of the option value of defaulting. This is consistent data on household assets. Under chapter 7 of the US bankruptcy law, consumers can keep all wealth up to an exemption level. I show that introducing exemption levels is of particular importance in the presence of wealth shocks. My quantitative evaluations show that changes in the exemption level have an impact only for very low exemption levels. Thus, ignoring them biases welfare results. But this impact fades out rather quickly. The reason is that almost no household is affected by medium to high exemption levels because those households who might default do not have much wealth. The welfare results of changes in the exemption level are rather small, less than 0.1% of annual consumption. In contrast to the earlier literature, but consistent with the data, I do not find a strong positive relationship between the exemption level and default rates

Joint Search and Aggregate Fluctuations

We develop a theory of incomplete markets where households that consist of two ex ante identical, and ex post heterogeneous agents can provide mutual insurance though adjustments in labor supply. We do so by taking stock from the vast literature of search models of the labor market and trace the differences between bachelor and couples household economies. Our main goal is to address whether joint search within the household unit can help reconcile the suggestive business cycle properties of aggregate employment, unemployment and labor force participation. We use data from the CPS on labor market transitions of married couples and we show that joint insurance is important factor in explaining why the labor force is nearly acyclical. When we turn to the model however we find that these predictions are not entirely consistent with our theory. We then go on to explore what important additions need to be made to our benchmark framework to bring the model closer to the data

Risk-sharing in heterogenous agent models with incomplete markets.

This thesis examines the impact of different risk sharing arrangements under incomplete financial markets on macroeconomic outcomes. The first two chapters are joint work with Giacomo Rodano. In the first chapter, we examine the effects of Chapter 7 of the US bankruptcy law on entrepreneurs. The latter are subject to production risk. They can borrow and in case they fail they can default on their debt. We examine the optimal wealth exemption level and the optimal credit market exclusion duration in this environment. In addition to unsecured credit, entrepreneurs can also obtain secured credit in the second chapter. Secured credit lowers the cost of a generous bankruptcy regime because agents who are rationed out of the unsecured credit market can still obtain secured credit. Therefore, the optimal exemption level is relatively high. In the third chapter, I investigate the effects of wealth exemptions on interest rates if entrepreneurs can choose the riskiness of their project. The default possibility leads to a kink in the value function which makes agents locally risk-loving. In the fourth chapter, I focus on consumers only. In particular, I show that wealth exemptions are of particular importance in a model with expense shocks. Wealth exemptions encourage people to save more so that aggregate savings rise. The model is also consistent with the fact that consumer bankruptcy cases are not correlated with wealth exemption levels. The fifth chapter is joint work with Rigas Oikonomou. We compare two environments: on the one hand the standard one in which a household consists of one member and, on the other hand, one in which a household consists of two members who share their risks perfectly. We investigate the differences between the two models in labor market flows and volatilities of labor market statistics in response to productivity shocks

Sovereign risk and bank fragility

We develop a model of bank risk-taking with strategic sovereign default risk. Domestic banks invest in real projects and purchase government bonds. While an increase in bond purchases crowds out profitable investments, it improves the government's incentives to repay and therefore lowers its borrowing costs. For low levels of government debt, banks influence their default risks through purchases of bonds. But, for high debt levels, this influence is lost since bank and government default are perfectly correlated. Banks fail to account for how their bond purchases influence the government's default incentives. This leads to socially inefficient levels of bond holdings

The rise of the added worker effect

We document that the added worker effect (AWE) has increased over the last three decades. We develop a search model with two earner households and we illustrate that the increase in the AWE from the 1980s to the 2000s can be explained through (i) the narrowing of the gender pay gap, (ii) changes in the frictions in the labor market and (iii) changes in the labor force participation costs of married women

Changes in education, wage inequality and working hours over time

The US skill premium and college enrollment have increased substantially over the past few decades. In addition, while low-wage earners worked more than highwage earners in 1970, the opposite was true in 2000. We show that a parsimonious neoclassical model featuring skill-biased technical change, endogenous education and labor supply decisions can explain the change in the college education rate between 1967 and 2000 as well as the trend in the wage-hours correlation. Moreover, we show analytically and quantitatively that endogenous labor supply is important. Assuming constant hours significantly biases the estimates of the effects of skillbiased technological progress on college enrollment and the skill premium. Further, we find that limiting the maximum number of hours someone can work lowers welfare for almost all generations. Since it increases the skill premium, the welfare loss is most severe for the low-skilled, reaching almost one percent of life-time consumption

Household Search and the Aggregate Labour Market

We develop a theoretical model with labour market frictions, incomplete financial markets, and with households which have two members. Households face unemployment risks, but their members adjust their labour supplies to insure against unemployment. We use the model to explain the cyclical properties of aggregate employment and participation. As in the U.S. data, the model predicts that the participation rate (the fraction of individuals that want jobs) is not strongly correlated with aggregate economic activity. This property is in sharp contrast to the strongly procyclical participation predicted by both neoclassical models and models with search frictions, when we assume bachelor households or households with infinitely many members (complete markets). In the two-member household model and in the data, primary earners are always in the labour force, secondary earners have a mildly countercyclical participation rate, and a mildly procyclical employment rate. Their behaviour insures the household against unemployment risks

Household search and the aggregate labor market

We develop a theoretical model with labor market frictions, incomplete financial markets and with households which have two members. Households face unemployment risks but their members adjust their labor supplies to insure against unemployment. We use the model to explain the cyclical properties of aggregate employment and participation. As in the US data, the model predicts that the participation rate (the fraction of individuals that want jobs) is not strongly correlated with aggregate economic activity. This property is in sharp contrast to the strongly procyclical participation predicted by both neoclassical models and models with search frictions, when we assume bachelor households or households with infinitely many members (complete markets). In the two member household model and in the data, primary earners are always in the labor force, secondary earners have a mildly countercyclical participation rate and a mildly procyclical employment rate. Their behavior insures the household against unemployment risks

The long and short of financing government spending

This paper shows that debt-financed fiscal multipliers vary depending on the maturity of debt issued to finance spending. Utilizing state-dependent SVAR models and local projections for post-war US data, we show that a fiscal expansion financed with short term debt increases output more than one financed with long term debt. The reason for this result is that only the former may lead to a significant increase in private consumption. We then construct an incomplete markets model in which households invest in long and short assets. Short assets have a lower return (in equilibrium) since they provide liquidity services, households can use them to cover sudden spending shocks. An increase in the supply of these assets through a short term debt financed government spending shock makes it easier for constrained households to meet their spending needs and therefore crowds in private consumption. We first prove this analytically in a simplified model and then show it in a calibrated standard New Keynesian model. We finally study the optimal policy under a Ramsey planner. The optimizing government faces a trade-off between the hedging value of long term debt, as its price decreases in response to adverse shocks, and the larger multiplier when it issues short term debt. We find that the latter effect dominates and that the optimal policy for the government is to finance spending predominantly with short term debt