A dynamic bargaining model of sovereign debt

Eduardo Fernandez-Arias

No 778, Policy Research Working Paper Series from The World Bank

Abstract: This paper models a dynamic bargaining game between a highly indebted country and its commercial bank consortium, to analyze the determinants of the resulting re-scheduling agreements and the net transfer of resources over time. The bargaining game is based on the simple paradigm that if no agreement is reached for a current payment, the banks would apply default sanctions. The author found that under general conditions settlements would be reached and default sanctions would not be applied in equilibrium. But the default sanctions would be a credible threat underlying the negotiations and determining the equilibrium payments. These equilibrium payments in turn would determine the credit ceiling and the later commercial discounts on the debt market. Unlike other bargaining games, this one explicitly models the debtor country's economic structure, featuring an import-dependent economy subject to foreign exchange and fiscal constraints. Moreover, the model is truly dynamic in the sense that the future negotiating environment is endogenously determined by current bargaining outcomes. Under plausible refinements and assumptions, the author obtains a closed-form solution for net transfers, dependent on various structural and policy parameters.

Keywords: Economic Theory&Research; Environmental Economics&Policies; Banks&Banking Reform; Strategic Debt Management; Financial Intermediation (search for similar items in EconPapers)
Date: 1991-10-31
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Citations: View citations in EconPapers (4)

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