On Sovereign Default With Time-Varying Interest Rates

Abstract

We extend and refine Aguiar and Amador (2019)’s contraction approach to Eaton and Gersovitz (1981)’s sovereign debt model. In particular, we encompass time-varying interest rates and growth. We show that, when long-term interest rates exceed growth, equilibrium is unique and can be computed via contraction mapping. The method unifies separate branches of literature, showing that the contraction property is the reflection of previous arbitrage arguments based on replication, inspired by Bulow and Rogoff (1989).

Keywords: Sovereign Default; Time-Varying Interest Rates; Uniqueness of Equilibrium; Contraction Mapping

JEL Classification: F34; F41