Self-Fulfilling Debt Crises, Revisited: The Art of the Desperate Deal
58 Pages Posted: 6 Mar 2017
Date Written: March 3, 2017
We revisit self-fulfilling rollover crises by introducing an alternative equilibrium selection that involves bond auctions at depressed but strictly positive equilibrium prices, a scenario in line with observed sovereign debt crises. We refer to these auctions as "desperate deals," the defining feature of which is a price schedule that makes the government indifferent to default or repayment. The government randomizes at the time of repayment, which we show can be implemented in pure strategies by introducing stochastic political payoffs or external bailouts. Quantitatively, auctions at fire-sale prices are crucial for generating realistic spread volatility.
Keywords: Sovereign Debt Crises
JEL Classification: F34
Suggested Citation: Suggested Citation