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The Impact of Personal Bankruptcy Law on Entrepreneurship

I study the two competing effects of limited personal liability on entrepreneurship in a life-cycle model: an insurance effect through debt relief in the event of business failure and a borrowing cost effect where the borrowing cost rises with default premiums. I first calibrate the model to the US economy by taking a simplified version of the US Chapter 7 bankruptcy code and then consider the effects of alternative regimes. I find that personal bankruptcy law affects entrepreneurship primarily by altering the decisions of agents with moderate entrepreneurial ability through the insurance effect rather than through the borrowing cost effect.