Does Inequality Cause Financial Distress? Evidence from Lottery Winners and Neighboring Bankruptcies

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FRB of Philadelphia Working Paper No. 16-4

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Sumit Agarwal; Vyacheslav Mikhed; Barry Scholnick
Income inequality; Bankruptcy; Conspicuous consumption; Lottery; Financial distress
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paper description
Revised Oct 2016. We test the hypothesis that income inequality causes financial distress. To identify the effect of income inequality, we examine lottery prizes of random dollar magnitudes in the context of very small neighborhoods (13 households on average). We find that a C$1,000 increase in the lottery prize causes a 2.4% rise in subsequent bankruptcies among the winners’ close neighbors. We also provide evidence of conspicuous consumption as a mechanism for this causal relationship. The size of lottery prizes increases the value of visible assets (houses, cars, motorcycles), but not invisible assets (cash and pensions), appearing on the balance sheets of neighboring bankruptcy filers.