Self-Fulfilling Debt Dilution: Maturity and Multiplicity in Debt Models

68 Pages Posted: 13 Jun 2018

See all articles by Mark Aguiar

Mark Aguiar

Princeton University

Manuel Amador

Federal Reserve Banks - Federal Reserve Bank of Minneapolis

Date Written: June 2018

Abstract

We establish that creditor beliefs regarding future borrowing can be self-fulfilling, leading to multiple equilibria with markedly different debt accumulation patterns. We characterize such indeterminacy in the Eaton-Gersovitz sovereign debt model augmented with long maturity bonds. Two necessary conditions for the multiplicity are: (i) the government is more impatient than foreign creditors, and (ii) there are deadweight losses from default; both are realistic and standard assumptions in the quantitative literature. The multiplicity is dynamic and stems from the self-fulfilling beliefs of how future creditors will price bonds; long maturity bonds are therefore a crucial component of the multiplicity. We introduce a third party with deep pockets to discuss the policy implications of this source of multiplicity and identify the potentially perverse consequences of traditional “lender of last resort” policies.

Suggested Citation

Aguiar, Mark and Amador, Manuel, Self-Fulfilling Debt Dilution: Maturity and Multiplicity in Debt Models (June 2018). NBER Working Paper No. w24683, Available at SSRN: https://ssrn.com/abstract=3194835

Mark Aguiar (Contact Author)

Princeton University ( email )

Princeton, NJ 08544-1021
United States

Manuel Amador

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

90 Hennepin Avenue
Minneapolis, MN 55480
United States

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