Beliefs and long-maturity sovereign debt

Zachary Stangebye ()

Journal of International Economics, 2020, vol. 127, issue C

Abstract: A novel form of strategic complementarities is explored in a standard quantitative model of long-maturity sovereign debt. Discrepancies in long-run beliefs dilute current prices differently. Negative long-run beliefs become self-fulfilling if the sovereign optimally borrows more and defaults more frequently in the face of worse prices. A strong curvature in the flow utility is an important ingredient in generating this response. The intuition bears out both through a multiplicity of Markov equilibria and in sunspot equilibria that mimic trigger strategies in repeated games. In the benchmark model, average spreads are roughly 67% higher (200 basis points) and debt-to-GDP ratios are roughly 9% higher (5 percentage points) when beliefs are pessimistic. The model also reveals limitations to third-party coordination of expectations as a policy tool.

Keywords: Sovereign debt crises; Belief-driven crises; Long-term debt (search for similar items in EconPapers)
JEL-codes: E44 F34 G01 H63 (search for similar items in EconPapers)
Date: 2020
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:inecon:v:127:y:2020:i:c:s0022199620300969

DOI: 10.1016/j.jinteco.2020.103381

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