Are household consumption decisions affected by past due unsecured debt? Theory and evidence

Abstract

We study delinquent and non‐performing loans in consumer credit markets and their implications for consumer behaviour. By introducing endogenously non‐payment of debt in the inter‐temporal optimization problem of a representative borrowing household, we derive analytically an augmented consumption Euler equation featuring a risk factor in terms of expected non‐performing debt and delinquent debt. We find that the presence of the risk factor differentiates the estimated values of the preference parameters and enhances the model's structure in comparison to the benchmark representative agent model with full debt repayment, which seems to be an incomplete description of consumer behaviour.

Consumer default and optimal consumption decisions

“…We next discuss some important issues regarding the estimation procedure and present the table with the empirical results. First, the measurement error, a widely discussed problem concerning the estimation of the consumption Euler equation, arises mainly from the log-linear approximation of the interest rate, both the borrowing and saving rate, the adoption of the rational expectations hypothesis and the existence of unobserved heterogeneity (see an analytical presentation of all these concerns in Bechlioulis and Brissimis, 2020). Second, the autocorrelation in the residuals seems to be an important issue regarding the estimated values of the preference parameters, as discussed by Sargan (1958) who argued that the non-existence of autocorrelation in measurement errors is rather unrealistic.…”