Model Of Sovereign Debt Research Articles

The role of institutions in reputation models of sovereign debt

A standard explanation for why sovereign governments repay their debts is that they must maintain a good reputation to easily borrow more. We show that the ability of reputation to support debt depends critically on the assumptions made about institutions. At one extreme, we assume that bankers can default on payments they owe to governments. At the other, we assume that bankers are committed to honoring contracts made with governments. We show that if bankers can default, then a government gets enduring benefits from maintaining a good relationship with bankers and its reputation can support a large amount of borrowing. If, however, bankers must honor their contracts, then a government gets only transient benefits from maintaining a good relationship and its reputation can support zero borrowing.

Repudiation and Renegotiation: The Case of Sovereign Debt

A model of sovereign debt is analyzed. In this model, renegotiation arises in a natural way. Because information is incomplete, the renegotiation game has many equilibria. The standard contract theory approach suggests that the parties should agree to choose the efficient equilibrium strategies when the contract is written. Refinements of the equilibrium notion, such as strategic stability, suggest that a very inefficient equilibrium may be chosen. The tension between these two approaches raises deep questions about the correct way to analyze a large class of contracting problems. Copyright 1989 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.