Sovereign Debt, Reputation, and Credit Terms

30 Pages Posted: 16 May 2011

See all articles by Jonathan Eaton

Jonathan Eaton

Pennsylvania State University, College of the Liberal Arts - Department of Economic

Date Written: August 1990

Abstract

I develop a model in which sovereign debtors repay debt in order to maintain a reputation for repayment. Repayment gives creditors reason to think that the debtor will suffer adverse consequences if it defaults, so they continue to lend. I compare a situation in which competitive lenders earn a zero profit on each loan with one in which they can make long-term commitments to individual borrowers, so that the zero-profit condition applies only in the long run. In many circumstances a borrower benefits, ex ante, if lenders commit to denying credit to a borrower in default even if at that point a subsequent loan is profitable. Furthermore, a "debt overhang," while possibly altering credit terms, does not cause profitable investment opportunities to go unexploited.

Suggested Citation

Eaton, Jonathan, Sovereign Debt, Reputation, and Credit Terms (August 1990). NBER Working Paper No. w3424, Available at SSRN: https://ssrn.com/abstract=1839144

Jonathan Eaton (Contact Author)

Pennsylvania State University, College of the Liberal Arts - Department of Economic ( email )

608 Kern Graduate Building
University Park, PA 16802-3306
United States
814-865-8871 (Phone)

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