Personal bankruptcy filings have increased particularly with the onset of the most recent financial crisis. While not a new phenomenon, the study of personal bankruptcy in Australia is, perhaps rather strangely, minimal. This thesis posits that other factors apart from misfortune contribute to increase the number of filings. It looks particularly at how procrastination in debt repayment contributes to increase an individual's probability of filing for bankruptcy.
This thesis presents a model of debt repayment that incorporates the idea that debtors can have time-inconsistent preferences when it comes to in debt repayment. Time-inconsistent preferences are modelled using the quasi-hyperbolic discount function. The model also incorporates the option to file for bankruptcy in the final period when debtors must repay their entire loan taken out in the first period. If debtors are insolvent, they can file for bankruptcy but if they are solvent, they must repay their debts because debtors must be insolvent to be considered eligible to file in Australia. In bankruptcy, the bankruptcy exemptions follow the structure of the Australian personal bankruptcy system.
It was found that ceteris paribus, time-inconsistent individuals who procrastinate in repaying their debts have a higher risk of insolvency because of the sheer size of the loan compounded over time as compared to if individuals had paid in regular instalments. This has negative consequences for debtors who actually manage to service their entire loan, because they pay more for compounded interest. On the other hand, procrastination is not necessarily welfare reducing for debtors if they file for bankruptcy later on. However, deadweight losses in the economy are greater when there are more time-inconsistent individuals in the economy, as lenders forfeit the opportunity to recover their loans and society bears costs arising from bankruptcy more often.
Furthermore, in an economy with time-inconsistent individuals, increases in the interest rates (prompted by increases in the exemptions in bankruptcy) have a two-way effect on the probability of insolvency. While they make debt repayment costlier, they induce some individuals (who would have liked to procrastinate on repaying their debts) to repay earlier, thereby reducing their probability of insolvency. In contrast, interest rate hikes only make repayment costlier and exacerbates the chances of filing in a time-consistent economy.