Learning and the dynamics of consumer unsecured debt and bankruptcies

During the Great Moderation, the consumer unsecured debt-to-income ratio nearly doubled and the personal bankruptcy filing rate more than quadrupled. This historically tranquil period ended in 2008 with a severe recession and a protracted credit crunch. We develop a theory of learning in which consumers and lenders adjust their beliefs about the riskiness of the economic environment over time in response to the realized sequence of aggregate shocks and then embed it into an otherwise standard quantitative model of consumer default. Simulations of the model suggest that learning can explain as much as half of the recent boom and bust cycle in consumer unsecured debt and a modest fraction of the rise in bankruptcy filings prior to 2005. (C) 2016 Elsevier B.V. All rights reserved.