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Competition and Intervention in Sovereign Debt Markets

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  • Bernhard Paasche
  • Stanley E. Zin

Abstract

We investigate markets for defaultable sovereign debt in which even though there are many identical lenders and symmetric information (including no hidden actions), perfect competition does not obtain. When a private lender allows a sovereign country to increase its level of indebtedness, that lender implicitly imposes a default externality on others who have lent to that sovereign. That is, in the case where the borrower would be able to pay back the first loan in the absence of a second loan, the borrower may have a strong incentive to take both loans and default on both loans. When a lender has no control over the actions of other lenders, they must anticipate this behavior and devise a lending strategy that is consistent with the strategies not only of the sovereign borrower, but also of other lenders. We develop a model of this strategic lending behavior in the presence of default, and show that even though there are many competing lenders, the perfectly competitive outcome does not necessarily obtain. Moreover, the equilibrium can result in monopoly-like outcomes in prices and quantities. We also study the consequences of intervention in these markets by a seemingly benevolent international financial institution, and find that these interventions, though well-intentioned, can in some cases be welfare reducing for sovereign countries and welfare improving for private lenders.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8679.

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Date of creation: Dec 2001
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Handle: RePEc:nbr:nberwo:8679

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  1. Barry Eichengreen, 1991. "Historical Research on International Lending and Debt," Journal of Economic Perspectives, American Economic Association, vol. 5(2), pages 149-169, Spring.
  2. Jonathan Eaton & Raquel Fernandez, 1995. "Sovereign Debt," NBER Working Papers 5131, National Bureau of Economic Research, Inc.
  3. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  4. Bulow, Jeremy & Rogoff, Kenneth, 1989. "Sovereign Debt: Is to Forgive to Forget?," American Economic Review, American Economic Association, vol. 79(1), pages 43-50, March.
  5. Pauly, Mark V, 1974. "Overinsurance and Public Provision of Insurance: The Roles of Moral Hazard and Adverse Selection," The Quarterly Journal of Economics, MIT Press, vol. 88(1), pages 44-62, February.
  6. Kletzer, Kenneth M, 1984. "Asymmetries of Information and LDC Borrowing with Sovereign Risk," Economic Journal, Royal Economic Society, vol. 94(374), pages 287-307, June.
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Cited by:
  1. Nicolas Melissas, 2009. "On Bid Disclosure in OCS Wildcat Auctions," Working Papers 0905, Centro de Investigacion Economica, ITAM.
  2. Jafarey, S. & Lahiri, S., 2005. "Developing country borrowing lending from a monopolistic lender: strategic interaction and endogenous leadership," Working Papers 05/06, Department of Economics, City University London.
  3. Sandra Lizarazo & Jose Maria Da-Rocha, 2009. "Money, Credit and Default," Working Papers 0908, Centro de Investigacion Economica, ITAM.
  4. Lizarazo, Sandra, 2010. "Default Risk and Risk Averse International Investors," MPRA Paper 20794, University Library of Munich, Germany.
  5. Subhayu Bandyopadhyay & Sajal Lahiri & Javed Younas, 2013. "Should Easier Access to Credit Replace Foreign Aid? A Trade-theoretic Analysis," Economics Bulletin, AccessEcon, vol. 33(3), pages 2320-2327.

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