Information as a Substitute for Bailouts in Sovereign Debt Markets

Abstract

Abstract This paper argues that multilateral financial institutions (MFIs), such as the International Monetary Fund, play an important informational role in international financial markets. By providing low-cost and high quality information, that is otherwise very costly for private lenders to obtain, the MFI allows a private lender to form a more accurate estimate of the credit-worthiness of a sovereign borrower. This creates a positive externality for private lenders and for sovereign borrowers with low risk credit ratings that are revealed by the provision of MFI information. The MFI can choose to internalize the negative externality created for sovereign borrowers who are revealed to be a higher credit risk by providing stand-by commitments to the sovereign. We construct a formal model of the private lenders decision to purchase costly information about the sovereign borrower. The model suggests that the free provision of MFI information has greater positive effects on financial markets the less risk-averse the private lender, the less information the private lender already has, the greater the size of the loan, and the smaller the expected default probability of the sovereign borrower.