On the contribution of game theory to the study of sovereign debt and default

This paper reviews the lessons learned from the application of the tools of game theory to the theoretical study of sovereign debt and default. We focus on two main questions. First, we review answers to the most fundamental question in the theory of sovereign debt: given that there is no supranational institution for enforcing the repayment of debts, why do countries ever repay their debts? Second, we review theories of the process by which sovereign debts are restructured with a view to answering the following question: why does the process of sovereign debt restructuring appear so inefficient? The first question raises issues in the design of self-enforcing contracts and on the credibility of threats to punish a country in default. The second question involves applications of the theory of bargaining in environments where the parties to a bargain cannot commit to honour the terms of the bargain or even commit to enter into negotiations in the first place. Copyright 2013, Oxford University Press.