Igor Livshits | Federal Reserve Bank of Philadelphia (original) (raw)
Papers by Igor Livshits
Working paper (Federal Reserve Bank of Philadelphia)
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Personal bankruptcies in the United States have increased dramatically, rising from 1.4 per thous... more Personal bankruptcies in the United States have increased dramatically, rising from 1.4 per thousand working age population in 1970 to 8.5 in 2002. We use a heterogeneous agent life-cycle model with competitive financial intermediaries who can observe households’ earnings, age and current asset holdings to evaluate several commonly offered explanations. We find that increased uncertainty (income shocks, expense uncertainty) cannot quantitatively account for the rise in bankruptcies. Instead, stories related to a change in the credit market environment are more plausible. In particular, we find that a combination of a decrease in the transactions cost of lending and a decline in the cost of bankruptcy does a good job in accounting for the rise in consumer bankruptcy. We also argue that the abolition of usury laws and other legal changes are unimportant.
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This paper studies the choice between general and speciflc human capital. A trade-ofi arises beca... more This paper studies the choice between general and speciflc human capital. A trade-ofi arises because general human capital, while less productive, can easily be reallocated across flrms. Accordingly, the fraction of individuals with speciflc human capital depends on the amount of uncertainty in the economy. Our model implies that while economies with more speciflc human capital tend to be more productive, they also tend to be more vulnerable to turbulence. As such, our theory sheds some light on the experience of Japan, where human capital is notoriously speciflc: while Japan beneflted from this predominately speciflc labor force in tranquil times, this speciflcity may also have been at the heart of its prolonged stagnation.
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This paper models credit histories as a way of aggregating information among various potential le... more This paper models credit histories as a way of aggregating information among various potential lenders, and is the first one to explicitly model how borrowers may affect this information aggregation through sequential borrowing. We analyze a dynamic economy with multiple competing lenders, who have heterogeneous private information about a consumer’s creditworthiness. We explore how this private information is aggregated through lending that take place over multiple stages. There are two key forces at play. On the one hand, acquiring a loan at an early stage serves as a positive signal—it allows the borrower to convey to other lenders the existence of a positively informed lender (advancing that early loan)—thereby convincing other lenders to extend further credit in future stages. On the other hand, because further lending dilutes existing loans (by increasing the consumer’s probability of default), the early lender takes this into account by charging a higher interest rate on the ...
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Consumer bankruptcy provides partial insurance against bad luck, but, by driving up interest rate... more Consumer bankruptcy provides partial insurance against bad luck, but, by driving up interest rates, makes life-cycle smoothing more difficult. We argue that to assess this trade-off one needs a quantitative model of consumer bankruptcy with three key features: life-cycle component, idiosyncratic earnings uncertainty, and expense uncertainty (exogenous negative shocks to household balance sheets). We find that transitory and persistent earnings shocks have very different implications for evaluating bankruptcy rules. More persistent shocks make the bankruptcy option more desirable. Larger transitory shocks have the opposite effect. Our findings suggest the current US bankruptcy system may be desirable for reasonable parameter values. (JEL D14, D91, K35)
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Several recent defaults on sovereign debt were accompanied by major bank-ing crises in the defaul... more Several recent defaults on sovereign debt were accompanied by major bank-ing crises in the defaulting countries. I argue that the banking crises, triggered by the defaults, were due to inadequate prudential regulations, which did not recognize the riskiness of the government debt. I use a simple model of pruden-tial regulation to illustrate this point. I further show that the failure to adjust prudential regulation can be a conscious decision of the government, rather than an oversight. When risky government debt is considered safe by the regulation, domestic banks gamble by constructing portfolios correlated with government default. These banks bid up the price of the government bonds, which lowers government’s cost of borrowing and may postpone (and give a chance to avoid) the default. I provide supporting evidence from the Russian 1998 crisis.
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Working paper (Federal Reserve Bank of Philadelphia), 2022
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Several recent defaults on sovereign debt were accompanied by major banking crises in the default... more Several recent defaults on sovereign debt were accompanied by major banking crises in the defaulting countries. I argue that the banking crises, triggered by the defaults, were due to inadequate prudential regulations, which did not recognize the riskiness of the government debt. I use a simple model of prudential regulation to illustrate this point. I further show that the failure to adjust prudential regulation can be a conscious decision of the government, rather than an oversight. When risky government debt is considered safe by the regulation, domestic banks gamble by constructing portfolios correlated with government default. These banks bid up the price of the government bonds, which lowers government’s cost of borrowing and may postpone (and give a chance to avoid) the default. I provide supporting evidence from the Russian 1998 crisis.
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Loose financial regulation encourages some banks to adopt a risky strategy of specializing in res... more Loose financial regulation encourages some banks to adopt a risky strategy of specializing in residential mortgages. In the event of an adverse aggregate housing shock, these banks fail. When banks do not fully internalize the losses from such failure (due to limited liability or deposit insurance), they offer mortgages at less than actuarially fair interest rates. This opens a door to home-ownership for some young low net-worth individuals. In turn, the additional demand from these new home-buyers drives up house prices. All of this leads to non-trivial distribution of gains and losses from lax regulation amongst the households. Renters and individuals with large non-housing wealth suffer from the fragility of the banking system induced by the lax regulation. On the other hand, some young middle-income households are able to get a mortgage and buy a house, thus benefiting from the lax regulation. Furthermore, the current (old) homeowners benefit from the increase in the price of th...
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Federal Reserve Bank of Philadelphia Working Paper Series, 2019
Banking regulation routinely designates some assets as safe and thus does not require banks to ho... more Banking regulation routinely designates some assets as safe and thus does not require banks to hold any additional capital to protect against losses from these assets. A typical such safe asset is domestic government debt. There are numerous examples of banking regulation treating domestic government bonds as ?safe,? even when there is clear risk of default on these bonds. We show, in a parsimonious model, that this failure to recognize the riskiness of government debt allows (and induces) domestic banks to ?gamble? with depositors? funds by purchasing risky government bonds (and assets closely correlated with them). A sovereign default in this environment then results in a banking crisis. Critically, we show that permitting banks to gamble this way lowers the cost of borrowing for the government. Thus, if the borrower and the regulator are the same entity (the government), that entity has an incentive to ignore the riskiness of the sovereign bonds. We present empirical evidence in ...
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Several recent defaults on sovereign debt were accompanied by major banking crises in the default... more Several recent defaults on sovereign debt were accompanied by major banking crises in the defaulting countries. I argue that the banking crises, triggered by the defaults, were due to inadequate prudential regulations, which did not recognize the riskiness of the government debt. I use a simple model of prudential regulation to illustrate this point. I further investigate whether these “inadequate regulations†can be part of a constrained optimal arrangement which increases the cost of default and permits the government to borrow more ex-ante
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There are large countercyclical fluctuations in U.S. bankruptcy filings and real credit card inte... more There are large countercyclical fluctuations in U.S. bankruptcy filings and real credit card interest rates, while unsecured credit is pro-cyclical. This paper documents the facts and asks whether the predictions of incomplete market models with bankruptcy are consistent with these facts. We introduce aggregate fluctuations into a heterogeneous agent life-cycle incomplete market model with a U.S. style bankruptcy regime. Household borrowing is priced by competitive financial intermediaries who can observe households’ earnings, age and current asset holdings. Aggregate fluctuations change the probability of persistent shocks to household earnings, with the likelihood of negative shocks increasing in recessions. This leads to asymmetric effects of credit pricing on different household types over the business cycles, since interest rates vary endogenously with borrowers’ default risk. The model is calibrated to match key features of the U.S. economy and bankruptcy system. When the only...
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Personal bankruptcy filings have increased dramatically: rising from 1.4 in per thousand of worki... more Personal bankruptcy filings have increased dramatically: rising from 1.4 in per thousand of working age population 1970 to 8.5 in 2002 in the United States and from 0.2 in 1970 to 4.3 in 2002 in Canada. This paper asks whether 6 commonly mentioned potential explanations -- financial innovation, financial market liberalization, an increase in household specific idiosyncratic risk, demographic changes, legal changes and decreased “stigma†-- can quantitatively account for the rise in consumer bankruptcies in the United States and Canada. We use a heterogeneous agent life cycle model with competitive intermediaries who are able to (imperfectly) observe households (labor) productivity, age and current asset holdings. We undertake numerical experiments to determine the extent to which each of the 5 factors can account for the rise in consumer bankruptcies. Our analysis suggests that financial innovation (the spread of credit scoring and new collateralized debt instruments) and financi...
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We quantitatively analyze consumer credit markets with behavioral consumers and default. Our mode... more We quantitatively analyze consumer credit markets with behavioral consumers and default. Our model incorporates over-optimistic and rational borrower types into a standard incomplete markets with consumer bankruptcy framework. Lenders price credit endogenously, forming beliefs - type scores - about borrowers' types. Since over-optimistic borrowers incorrectly believe they have rational beliefs, lenders do not need to take strategic behavior into account when updating type scores. We find that the partial pooling of over-optimistic with rational borrowers results in spill-overs across types via interest rates, with over-optimists being cross-subsidized by rational consumers who have lower default rates. Higher interest rates lower the average debt level of realists compared to a world without over-optimists. Due to overestimating their ability to repay, over-optimists borrow too much. We evaluate three policies to address these frictions: reducing the cost of default, educating o...
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Public policy debate around consumer credit has focused on consumer protection. But from whom are... more Public policy debate around consumer credit has focused on consumer protection. But from whom are we protecting these borrowers?
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This paper proves an analogue of Pratt's theorem for two measures of risk aversion for mean-v... more This paper proves an analogue of Pratt's theorem for two measures of risk aversion for mean-variance preferences. A direct link is established between these measures and standard measures of risk aversion. Implications for problems of choice under uncertainty such as portfolio choice problems are derived. This paper establishes the equivalence of two measures of risk aversion for a general class of mean-variance preferences. It further derives implications for decision making under uncertainty, and establishes portfolio characterization of risk aversion for mean- variance preferences, which allows for comparison of agents' attitudes toward risk based on the choices they make under uncertainty. The motivation for studying mean-variance preferences is twofold: 1) they are widely used in finance; and 2) Epstein (1985) has shown that in the class of Machina's (1982) non-expected utility preferences only mean-variance preferences satisfy appropriate decreasing-absolute- risk-...
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Working paper (Federal Reserve Bank of Philadelphia)
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Personal bankruptcies in the United States have increased dramatically, rising from 1.4 per thous... more Personal bankruptcies in the United States have increased dramatically, rising from 1.4 per thousand working age population in 1970 to 8.5 in 2002. We use a heterogeneous agent life-cycle model with competitive financial intermediaries who can observe households’ earnings, age and current asset holdings to evaluate several commonly offered explanations. We find that increased uncertainty (income shocks, expense uncertainty) cannot quantitatively account for the rise in bankruptcies. Instead, stories related to a change in the credit market environment are more plausible. In particular, we find that a combination of a decrease in the transactions cost of lending and a decline in the cost of bankruptcy does a good job in accounting for the rise in consumer bankruptcy. We also argue that the abolition of usury laws and other legal changes are unimportant.
Bookmarks Related papers MentionsView impact
Bookmarks Related papers MentionsView impact
This paper studies the choice between general and speciflc human capital. A trade-ofi arises beca... more This paper studies the choice between general and speciflc human capital. A trade-ofi arises because general human capital, while less productive, can easily be reallocated across flrms. Accordingly, the fraction of individuals with speciflc human capital depends on the amount of uncertainty in the economy. Our model implies that while economies with more speciflc human capital tend to be more productive, they also tend to be more vulnerable to turbulence. As such, our theory sheds some light on the experience of Japan, where human capital is notoriously speciflc: while Japan beneflted from this predominately speciflc labor force in tranquil times, this speciflcity may also have been at the heart of its prolonged stagnation.
Bookmarks Related papers MentionsView impact
This paper models credit histories as a way of aggregating information among various potential le... more This paper models credit histories as a way of aggregating information among various potential lenders, and is the first one to explicitly model how borrowers may affect this information aggregation through sequential borrowing. We analyze a dynamic economy with multiple competing lenders, who have heterogeneous private information about a consumer’s creditworthiness. We explore how this private information is aggregated through lending that take place over multiple stages. There are two key forces at play. On the one hand, acquiring a loan at an early stage serves as a positive signal—it allows the borrower to convey to other lenders the existence of a positively informed lender (advancing that early loan)—thereby convincing other lenders to extend further credit in future stages. On the other hand, because further lending dilutes existing loans (by increasing the consumer’s probability of default), the early lender takes this into account by charging a higher interest rate on the ...
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Bookmarks Related papers MentionsView impact
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Consumer bankruptcy provides partial insurance against bad luck, but, by driving up interest rate... more Consumer bankruptcy provides partial insurance against bad luck, but, by driving up interest rates, makes life-cycle smoothing more difficult. We argue that to assess this trade-off one needs a quantitative model of consumer bankruptcy with three key features: life-cycle component, idiosyncratic earnings uncertainty, and expense uncertainty (exogenous negative shocks to household balance sheets). We find that transitory and persistent earnings shocks have very different implications for evaluating bankruptcy rules. More persistent shocks make the bankruptcy option more desirable. Larger transitory shocks have the opposite effect. Our findings suggest the current US bankruptcy system may be desirable for reasonable parameter values. (JEL D14, D91, K35)
Bookmarks Related papers MentionsView impact
Several recent defaults on sovereign debt were accompanied by major bank-ing crises in the defaul... more Several recent defaults on sovereign debt were accompanied by major bank-ing crises in the defaulting countries. I argue that the banking crises, triggered by the defaults, were due to inadequate prudential regulations, which did not recognize the riskiness of the government debt. I use a simple model of pruden-tial regulation to illustrate this point. I further show that the failure to adjust prudential regulation can be a conscious decision of the government, rather than an oversight. When risky government debt is considered safe by the regulation, domestic banks gamble by constructing portfolios correlated with government default. These banks bid up the price of the government bonds, which lowers government’s cost of borrowing and may postpone (and give a chance to avoid) the default. I provide supporting evidence from the Russian 1998 crisis.
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Working paper (Federal Reserve Bank of Philadelphia), 2022
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Several recent defaults on sovereign debt were accompanied by major banking crises in the default... more Several recent defaults on sovereign debt were accompanied by major banking crises in the defaulting countries. I argue that the banking crises, triggered by the defaults, were due to inadequate prudential regulations, which did not recognize the riskiness of the government debt. I use a simple model of prudential regulation to illustrate this point. I further show that the failure to adjust prudential regulation can be a conscious decision of the government, rather than an oversight. When risky government debt is considered safe by the regulation, domestic banks gamble by constructing portfolios correlated with government default. These banks bid up the price of the government bonds, which lowers government’s cost of borrowing and may postpone (and give a chance to avoid) the default. I provide supporting evidence from the Russian 1998 crisis.
Bookmarks Related papers MentionsView impact
Loose financial regulation encourages some banks to adopt a risky strategy of specializing in res... more Loose financial regulation encourages some banks to adopt a risky strategy of specializing in residential mortgages. In the event of an adverse aggregate housing shock, these banks fail. When banks do not fully internalize the losses from such failure (due to limited liability or deposit insurance), they offer mortgages at less than actuarially fair interest rates. This opens a door to home-ownership for some young low net-worth individuals. In turn, the additional demand from these new home-buyers drives up house prices. All of this leads to non-trivial distribution of gains and losses from lax regulation amongst the households. Renters and individuals with large non-housing wealth suffer from the fragility of the banking system induced by the lax regulation. On the other hand, some young middle-income households are able to get a mortgage and buy a house, thus benefiting from the lax regulation. Furthermore, the current (old) homeowners benefit from the increase in the price of th...
Bookmarks Related papers MentionsView impact
Federal Reserve Bank of Philadelphia Working Paper Series, 2019
Banking regulation routinely designates some assets as safe and thus does not require banks to ho... more Banking regulation routinely designates some assets as safe and thus does not require banks to hold any additional capital to protect against losses from these assets. A typical such safe asset is domestic government debt. There are numerous examples of banking regulation treating domestic government bonds as ?safe,? even when there is clear risk of default on these bonds. We show, in a parsimonious model, that this failure to recognize the riskiness of government debt allows (and induces) domestic banks to ?gamble? with depositors? funds by purchasing risky government bonds (and assets closely correlated with them). A sovereign default in this environment then results in a banking crisis. Critically, we show that permitting banks to gamble this way lowers the cost of borrowing for the government. Thus, if the borrower and the regulator are the same entity (the government), that entity has an incentive to ignore the riskiness of the sovereign bonds. We present empirical evidence in ...
Bookmarks Related papers MentionsView impact
Several recent defaults on sovereign debt were accompanied by major banking crises in the default... more Several recent defaults on sovereign debt were accompanied by major banking crises in the defaulting countries. I argue that the banking crises, triggered by the defaults, were due to inadequate prudential regulations, which did not recognize the riskiness of the government debt. I use a simple model of prudential regulation to illustrate this point. I further investigate whether these “inadequate regulations†can be part of a constrained optimal arrangement which increases the cost of default and permits the government to borrow more ex-ante
Bookmarks Related papers MentionsView impact
There are large countercyclical fluctuations in U.S. bankruptcy filings and real credit card inte... more There are large countercyclical fluctuations in U.S. bankruptcy filings and real credit card interest rates, while unsecured credit is pro-cyclical. This paper documents the facts and asks whether the predictions of incomplete market models with bankruptcy are consistent with these facts. We introduce aggregate fluctuations into a heterogeneous agent life-cycle incomplete market model with a U.S. style bankruptcy regime. Household borrowing is priced by competitive financial intermediaries who can observe households’ earnings, age and current asset holdings. Aggregate fluctuations change the probability of persistent shocks to household earnings, with the likelihood of negative shocks increasing in recessions. This leads to asymmetric effects of credit pricing on different household types over the business cycles, since interest rates vary endogenously with borrowers’ default risk. The model is calibrated to match key features of the U.S. economy and bankruptcy system. When the only...
Bookmarks Related papers MentionsView impact
Personal bankruptcy filings have increased dramatically: rising from 1.4 in per thousand of worki... more Personal bankruptcy filings have increased dramatically: rising from 1.4 in per thousand of working age population 1970 to 8.5 in 2002 in the United States and from 0.2 in 1970 to 4.3 in 2002 in Canada. This paper asks whether 6 commonly mentioned potential explanations -- financial innovation, financial market liberalization, an increase in household specific idiosyncratic risk, demographic changes, legal changes and decreased “stigma†-- can quantitatively account for the rise in consumer bankruptcies in the United States and Canada. We use a heterogeneous agent life cycle model with competitive intermediaries who are able to (imperfectly) observe households (labor) productivity, age and current asset holdings. We undertake numerical experiments to determine the extent to which each of the 5 factors can account for the rise in consumer bankruptcies. Our analysis suggests that financial innovation (the spread of credit scoring and new collateralized debt instruments) and financi...
Bookmarks Related papers MentionsView impact
We quantitatively analyze consumer credit markets with behavioral consumers and default. Our mode... more We quantitatively analyze consumer credit markets with behavioral consumers and default. Our model incorporates over-optimistic and rational borrower types into a standard incomplete markets with consumer bankruptcy framework. Lenders price credit endogenously, forming beliefs - type scores - about borrowers' types. Since over-optimistic borrowers incorrectly believe they have rational beliefs, lenders do not need to take strategic behavior into account when updating type scores. We find that the partial pooling of over-optimistic with rational borrowers results in spill-overs across types via interest rates, with over-optimists being cross-subsidized by rational consumers who have lower default rates. Higher interest rates lower the average debt level of realists compared to a world without over-optimists. Due to overestimating their ability to repay, over-optimists borrow too much. We evaluate three policies to address these frictions: reducing the cost of default, educating o...
Bookmarks Related papers MentionsView impact
Public policy debate around consumer credit has focused on consumer protection. But from whom are... more Public policy debate around consumer credit has focused on consumer protection. But from whom are we protecting these borrowers?
Bookmarks Related papers MentionsView impact
Bookmarks Related papers MentionsView impact
This paper proves an analogue of Pratt's theorem for two measures of risk aversion for mean-v... more This paper proves an analogue of Pratt's theorem for two measures of risk aversion for mean-variance preferences. A direct link is established between these measures and standard measures of risk aversion. Implications for problems of choice under uncertainty such as portfolio choice problems are derived. This paper establishes the equivalence of two measures of risk aversion for a general class of mean-variance preferences. It further derives implications for decision making under uncertainty, and establishes portfolio characterization of risk aversion for mean- variance preferences, which allows for comparison of agents' attitudes toward risk based on the choices they make under uncertainty. The motivation for studying mean-variance preferences is twofold: 1) they are widely used in finance; and 2) Epstein (1985) has shown that in the class of Machina's (1982) non-expected utility preferences only mean-variance preferences satisfy appropriate decreasing-absolute- risk-...
Bookmarks Related papers MentionsView impact