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Information, Insurance and the Sustainability of Sovereign Debt

Listed author(s):
  • Toan Phan

    (University of North Carolina Chapel Hill)

In an influential paper, Bulow and Rogoff (1989) prove that in a competitive financial market, the threat of credit exclusion alone cannot sustain repayment of sovereign debt, as the defaulting government can still enter cash-in-advance insurance contracts. However, their result relies on an important assumption: symmetric information. This paper shows that if a debtor government has some private information about the underlying distribution of future economic shocks, then debt repayment is sustainable. This is true even if there is only one period with private information, and even if default does not have a spillover effect to any other relationship. The intuition is that a default is a signal of a bad distribution of future shocks, leading to higher risk premia on future financial contracts. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2016.06.006
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Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 22 (2016)
Issue (Month): (October)
Pages: 93-108

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Handle: RePEc:red:issued:15-136
DOI: 10.1016/j.red.2016.06.006
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