Unique Equilibrium in the Eaton-Gersovitz Model of Sovereign Debt

Abstract

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