Reputation and Sovereign Default

40 Pages Posted: 13 Jun 2018 Last revised: 3 Sep 2021

See all articles by Manuel Amador

Manuel Amador

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Christopher Phelan

University of Minnesota - Minneapolis

Date Written: June 2018

Abstract

This paper presents a continuous-time model of sovereign debt. In it, a relatively impatient sovereign government's hidden type switches back and forth between a commitment type, which cannot default, and an optimizing type, which can default at any time, and assume outside lenders have particular beliefs regarding how a commitment type should borrow for any given level of debt and bond price. If these beliefs satisfy reasonable assumptions, in any Markov equilibrium, the optimizing type mimics the commitment type when borrowing, revealing its type only by defaulting on its debt at random times. Further, in such Markov equilibria (the solution to a simple pair of ordinary differential equations), there are positive gross issuances at all dates, constant net imports as long as there is a positive equilibrium probability that the government is the optimizing type, and net debt repayment only by the commitment type. For countries that have recently defaulted, the interest rate the country pays on its debt is a decreasing function of the amount of time since its last default, and its total debt is an increasing function of the amount of time since its last default. For countries that have not recently defaulted, interest rates are constant.

Suggested Citation

Amador, Manuel and Phelan, Christopher, Reputation and Sovereign Default (June 2018). Available at SSRN: https://ssrn.com/abstract=3194834

Manuel Amador (Contact Author)

Federal Reserve Banks - Federal Reserve Bank of Minneapolis ( email )

90 Hennepin Avenue
Minneapolis, MN 55480
United States

Christopher Phelan

University of Minnesota - Minneapolis

420 Delaware St SE
Minneapolis, MN 55454
United States

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