Evidence for Dynamic Contracts in Sovereign Bank Lending
Central European University (CEU) - Department of Economics; National Bank of Hungary - Economics & Research Department
Cosmin L. Ilut
April 1, 2011
Economic Research Initiatives at Duke (ERID) Working Paper No. 96
This paper presents direct evidence for self-enforcing dynamic contracts in sovereign bank lending. Unlike the existing empirical literature, its instrumental variables method allows for distinguishing a direct influence of past repayment problems on current spreads (a punishment effect in prices) from an indirect effect through higher expected future default probabilities. Such a punishment provides positive surplus to lenders after a default, a feature that characterizes dynamic contracts. Using data on bank loans to developing countries between 1973-1981 and constructing continuous variables for credit history, we find evidence that most of the influence of past repayment problems is through the direct, punishment channel.
Number of Pages in PDF File: 31
Keywords: reputation, dynamic contracts, sovereign bank loan spreads, rational expectations, default risk
JEL Classification: C73, D86, F34, G12, G14, G15Accepted Paper Series
Date posted: April 21, 2011
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