Can Debt Crises Be Self-Fulfilling?
22 Pages Posted: 15 Feb 2006
Date Written: June 2004
Several papers argue that debt crises can be the result of self-fulfilling expectations that no one will lend to a country. I show this type of coordination failure can be eliminated by a combination of state-contingent securities and a mechanism that allows investors to promise to lend only if enough other investors do so as well. This suggests that runs on the debt of a single borrower (such as the government) can be eliminated, and that self-fulfilling features are more plausible when articulated in a context in which externalities among many decentralized borrowers allow for economy-wide debt runs to occur.
Keywords: Debt crises, multiple equilibria, liquidity, financial innovation
JEL Classification: E60, F30, F34, G13
Suggested Citation: Suggested Citation