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

See all articles by Adrien Auclert

Adrien Auclert

Stanford University - Department of Economics

Matthew Rognlie

Massachusetts Institute of Technology (MIT) - Department of Economics

Date Written: October 2015

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

Suggested Citation

Auclert, Adrien and Rognlie, Matthew, Unique Equilibrium in the Eaton-Gersovitz Model of Sovereign Debt (October 2015). MIT Department of Economics Graduate Student Research Paper No. 14-01 , Available at SSRN: https://ssrn.com/abstract=2470676 or http://dx.doi.org/10.2139/ssrn.2470676

Adrien Auclert (Contact Author)

Stanford University - Department of Economics ( email )

Landau Economics Building
579 Serra Mall
Stanford, CA 94305-6072
United States

Matthew Rognlie

Massachusetts Institute of Technology (MIT) - Department of Economics ( email )

77 Massachusetts Avenue
E19-750
Cambridge, MA 02139
United States

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