Unique Equilibrium in the Eaton-Gersovitz Model of Sovereign Debt
MIT Department of Economics Graduate Student Research Paper No. 14-01
35 Pages Posted: 26 Jul 2014 Last revised: 13 Oct 2015
Date Written: October 2015
A common view of sovereign debt markets is that they are prone to multiple equilibria. We show that such multiplicity does not exist in the infinite-horizon model of Eaton and Gersovitz (1981), a widely adopted benchmark for analyses of these markets. When the value from government default is exogenous, the model features a unique Markov perfect equilibrium, which is also its unique subgame perfect equilibrium. We extend this uniqueness result to two alternative environments: one in which governments face a positive bound on the assets they can accumulate before default, and one in which they are allowed to re-access financial markets after default. Our results show that no improvement in a borrower’s reputation for repayment can be self-sustaining, thereby strengthening the Bulow and Rogoff (1989) argument that debt cannot be sustained by reputation alone.
Keywords: sovereign debt, default, multiplicity
JEL Classification: E44, F34, F41, H63
Suggested Citation: Suggested Citation