ASSET EXEMPTION IN BANKRUPTCY, ACCESS TO AND COST OF CREDIT

Under the US personal bankruptcy law, exempt assets are not liquidated following bankruptcy. Entrepreneurs can undo such a protection by posting collateral. We provide a complete characterization of the interplay between asset exemption from liquidation upon default and adverse selection in a competitive credit market. Severe adverse selection induces separation, with safer entrepreneurs choosing loan contracts characterized by high collateral requirements, lower cost of credit and credit rationing for wealth-constraints applicants. Irrespective of adverse selec- tion, poor safe entrepreneurs pool as they face too much rationing, otherwise. Higher exemption makes collateral more informative. Evidence from the SSBF survey supports our theory.