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Self-Fulfilling Debt Dilution: Maturity and Multiplicity in Debt Models

Mark Aguiar and Manuel Amador

No 24683, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We establish that creditor beliefs regarding future borrowing can be self-fulfilling, leading to multiple equilibria with markedly different debt accumulation patterns. We characterize such indeterminacy in the Eaton-Gersovitz sovereign debt model augmented with long maturity bonds. Two necessary conditions for the multiplicity are: (i) the government is more impatient than foreign creditors, and (ii) there are deadweight losses from default; both are realistic and standard assumptions in the quantitative literature. The multiplicity is dynamic and stems from the self-fulfilling beliefs of how future creditors will price bonds; long maturity bonds are therefore a crucial component of the multiplicity. We introduce a third party with deep pockets to discuss the policy implications of this source of multiplicity and identify the potentially perverse consequences of traditional “lender of last resort” policies.

JEL-codes: F3 F34 (search for similar items in EconPapers)
Date: 2018-06
New Economics Papers: this item is included in nep-dge and nep-opm
Note: EFG IFM
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Published as Mark Aguiar & Manuel Amador, 2020. "Self-Fulfilling Debt Dilution: Maturity and Multiplicity in Debt Models," American Economic Review, vol 110(9), pages 2783-2818.

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