Reputation and Sovereign Default

Christopher Phelan and Manuel Amador

No 1167, 2017 Meeting Papers from Society for Economic Dynamics

Abstract: This paper presents a continuous time model of sovereign debt. In it, a relatively impatient sovereign government's hidden type switches back and forth between a behavioral type which cannot default and follows a set rule governing its borrowing as a function of its current debt and the price at which it can issue additional bonds, and an optimizing type which can default on the country’s debt at any time. We show that in the unique Markov perfect equilibrium, the optimizing type mimics the behavioral type when borrowing, revealing its type only by defaulting on its debt at random times. The Markov perfect equilibrium (the solution to a simple pair of ordinary differential equations) displays positive gross issuances at all dates, constant net imports as long as there is a positive equilibrium probability the government is the optimizing type, and net debt repayment only by the behavioral type. For countries which have recently defaulted, the interest rate the country pays on its debt is a decreasing function of the amount of time since its last default, its total debt is an increasing function of the amount of time since its last default, and the yield curve on its debt is downward sloping. For countries which have not recently defaulted, interest rates are constant and yield curves are flat.

Date: 2017
New Economics Papers: this item is included in nep-dge and nep-opm
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Related works:
Working Paper: Reputation and Sovereign Default (2018)
Working Paper: Reputation and Sovereign Default (2018)
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed017:1167

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