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Fragile Debt and the Credible Sharing of Strategic Uncertainty

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  • Russell Cooper
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    Abstract

    This paper studies debt fragility. It provides conditions under which fundamentals and strategic uncertainty jointly determine the price of sovereign debt. Default arises in equilibrium both because of fundamental shocks and beliefs. The probability of default depends on borrowing rates and, in equilibrium, on the beliefs of lenders about this probability. This interaction creates a strategic complementarity and thus the basis for strategic uncertainty. The paper analyzes the role of debt guarantees as a means of sharing both fundamental and strategic uncertainty. It provides conditions for the credibility of those guarantees as well as ex post bailouts. The effects of debt purchases by a monetary authority are analyzed as well.

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    Bibliographic Info

    Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 18377.

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    Date of creation: Sep 2012
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    Handle: RePEc:nbr:nberwo:18377

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    1. Tirole, Jean, 1985. "Asset Bubbles and Overlapping Generations," Econometrica, Econometric Society, Econometric Society, vol. 53(6), pages 1499-1528, November.
    2. De Grauwe, Paul & Ji, Yuemei, 2012. "Mispricing of Sovereign Risk and Multiple Equilibria in the Eurozone," CEPS Papers, Centre for European Policy Studies 6548, Centre for European Policy Studies.
    3. BIGELOW, J. & COOPER, R. & Tom Ross, 1988. "Warranties Without Commitment To Market Participation," Carleton Industrial Organization Research Unit (CIORU), Carleton University, Department of Economics 88-02, Carleton University, Department of Economics.
    4. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, American Economic Association, vol. 78(4), pages 647-61, September.
    5. Cole, Harold L & Kehoe, Timothy J, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 67(1), pages 91-116, January.
    6. Russell Cooper & Hubert Kempf & Dan Peled, 2008. "Is It Is Or Is It Ain'T My Obligation? Regional Debt In A Fiscal Federation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 49(4), pages 1469-1504, November.
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    Cited by:
    1. König, Philipp & Anand, Kartik & Heinemann, Frank, 2013. "The ‘Celtic Crisis’: Guarantees, transparency, and systemic liquidity risk," Annual Conference 2013 (Duesseldorf): Competition Policy and Regulation in a Global Economic Order 79747, Verein für Socialpolitik / German Economic Association.
    2. Roberto Tamborini, 2012. "Market opinions, fundamentals and the euro-sovereign debt crisis," Department of Economics Working Papers, Department of Economics, University of Trento, Italia 1210, Department of Economics, University of Trento, Italia.
    3. Saleem Bahaj, 2014. "Systemic Sovereign Risk: Macroeconomic Implications in the Euro Area," Discussion Papers 1406, Centre for Macroeconomics (CFM).
    4. Russell Cooper & Kalin Nikolov, 2013. "Government Debt and Banking Fragility: The Spreading of Strategic Uncertainty," NBER Working Papers 19278, National Bureau of Economic Research, Inc.
    5. Giancarlo Corsetti & Luca Dedola, 2012. "The "Mystery of the Printing Press" Monetary Policy and Self-fulfilling Debt Crises," Discussion Papers 1424, Centre for Macroeconomics (CFM), revised Aug 2014.

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