Default and Sovereign Debt

Franco Praussello

Economia Internazionale / International Economics, 1991, vol. 44, issue 4, 359-408

Abstract: This paper contains a comprehensive treatment of the main analytical issues pertaining to the sovereign debt theory. As red thread for the study emergence of default in alternative formal frameworks is traced and identified, in its different forms ranging from insolvency or illiquidity to repudiation and to its general meaning of breach of a clause in the initial loan contract. The growing literature on the sovereign debt is surveyed on the basis of a distinction between static and dynamic models, as well as non optimizing and optimizing models, where assumptions of rational behavior may hold only for the borrower or for the lender too. Moreover, consequences of default are investigated, along with conditions for achieving efficiency in case of renegotiation of the initial credit contract. The paper addresses the modem versions of well known analytical tools as the two gap mode, the transfer or approach with new cases of paradoxical and immiserising results, the debt cycle or the growth-cum-debt model, along with extensions on recent approaches as the pure theory of country risk, in the presence of different specifications of the penalty imposed on the borrower that chooses to repudiate. It is also shown the impact of inefficiencies in the market structure and of agents information conditions on the different possible equilibrium outcomes. In addition, in case of debt overhang, conditions are described that render debt relief profitable for the lender too.

Date: 1991
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