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Self-fulfilling and Self-enforcing Debt Crises

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  • Cohen, Daniel
  • Villemot, Sébastien

Abstract

We distinguish two attitudes towards debt. The attitude of prudent borrowers, which attempt to stabilize their debts to low levels, even in the event of a bad shock, and what we call, after Krugman, "Panglossian" borrowers, which only focus on the best of their growth prospects, and rationally anticipate to default on their debt when hit by a bad shock. We show empirically that this distinction is consistent with the data. Past a threshold of risk which, we show, corresponds to a spread of about 450 basis points, countries fail to respond to bad shocks and let their risk drift accordingly. We also distinguish two types of debt crises. Those which are the effect of an exogenous shock, and those which are self-fulfillingly created by the financial markets themselves. We show that the large majority of crises are of the first kind, although the probability of self-fulfilling cases is not negligible.

Suggested Citation

  • Cohen, Daniel & Villemot, Sébastien, 2008. "Self-fulfilling and Self-enforcing Debt Crises," CEPR Discussion Papers 6718, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:6718
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    Cited by:

    1. Juan Carlos Conesa & Timothy J. Kehoe, 2017. "Gambling for redemption and self-fulfilling debt crises," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 64(4), pages 707-740, December.

    More about this item

    Keywords

    Self-fulfilling crises; Sovereign debt;

    JEL classification:

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

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