Peer Financial Distress and Individual Leverage

Abstract

Abstract Using health shocks to identify financial distress situations, I document that peer distress leads to a decline in individual leverage and debt on average. Individual leverage declines by 5.7% and remains deflated for at least five years following peer distress. This decline occurs as individuals borrow less on the intensive margin, pay higher fractions of their debt and save more while their income remains unchanged. As a result, individuals are less likely to default during the period following peer distress. The heterogeneity in responses highlight the role of changes in beliefs and preferences as the underlying mechanism. (JEL D10, D12, D14, D84, H31, R20) Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.