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

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  • Mark Aguiar
  • Manuel Amador

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.

Suggested Citation

  • Mark Aguiar & Manuel Amador, 2018. "Self-Fulfilling Debt Dilution: Maturity and Multiplicity in Debt Models," Staff Report 565, Federal Reserve Bank of Minneapolis.
    • Handle: RePEc:fip:fedmsr:565
    DOI: 10.21034/sr.565
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    Cited by:

    1. Manuel Amador & Javier Bianchi, 2021. "Bank Runs, Fragility, and Credit Easing," Working Papers 785, Federal Reserve Bank of Minneapolis.
    2. Corsetti, Giancarlo & Maeng, Seung Hyun, 2020. "Debt Crises, Fast and Slow," CEPR Discussion Papers 14868, C.E.P.R. Discussion Papers.
    3. Galli, Carlo, 2021. "Self-fulfilling debt crises, fiscal policy and investment," Journal of International Economics, Elsevier, vol. 131(C).
    4. Joao Ayres & Gaston Navarro & Juan Pablo Nicolini & Pedro Teles, 2019. "Self-Fulfilling Debt Crises with Long Stagnations," Working Papers 757, Federal Reserve Bank of Minneapolis.
    5. Arce, Fernando, 2021. "Private Overborrowing under Sovereign Risk," MPRA Paper 113176, University Library of Munich, Germany.
    6. Andrea Gamba & Alessio Saretto, 2023. "Debt Maturity and Commitment on Firm Policies," Working Papers 2303, Federal Reserve Bank of Dallas.
    7. Flavia Corneli, 2024. "Sovereign debt maturity structure and its costs," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 31(1), pages 262-297, February.
    8. Giancarlo Corsetti, 2023. "Debt crises, fast and slow Giancarlo," RSCAS Working Papers 2023/15, European University Institute.
    9. Vincenzo Cuciniello & Claudio Michelacci & Luigi Paciello, 2023. "Subsidizing business entry in competitive credit markets," Temi di discussione (Economic working papers) 1424, Bank of Italy, Economic Research and International Relations Area.
    10. Aubhik Khan & Soyoung Lee, 2023. "Persistent Debt and Business Cycles in an Economy with Production Heterogeneity," Staff Working Papers 23-17, Bank of Canada.
    11. Giovanni Callegari & Ramon Marimon & Adrien Wicht & Luca Zavalloni, 2023. "On a Lender of Last Resort with a Central Bank and a Stability Fund," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 50, pages 106-130, October.
    12. Li, Yuan & Yang, Jinqiang & Zhao, Siqi, 2022. "Present-biased government and sovereign debt dynamics," Journal of Mathematical Economics, Elsevier, vol. 98(C).
    13. Zachary Stangebye, 2023. "Long-Term Sovereign Debt: A Steady State Analysis," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 48, pages 107-131, April.
    14. Aguiar, Mark & Amador, Manuel, 2019. "A contraction for sovereign debt models," Journal of Economic Theory, Elsevier, vol. 183(C), pages 842-875.

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    More about this item

    Keywords

    Self-fulfilling debt crises; Sovereign debt; Debt dilution; Multiple equilibria;
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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