Sovereign Debt, Reputation, And Credit Terms
This paper develops a model in which sovereign debtors repay debt in order to maintain a reputation for repayment. Repayment gives creditors reason to think that the debtor will suffer adverse consequences if the debtor defaults, so they continue to lend. I compare a situation in which competitive lenders earn zero profit on each loan with one in which they can make long-term commitments to individual borrowers, so that the zero-profit condition applies only in the long run. In many circumstances, a borrower benefits ex ante if lenders commit to denying credit to a borrower in default even if, at that point, a subsequent loan is profitable. Furthermore, a "debt overhang," while possibly altering credit terms, does not cause profitable investment opportunities to go unexploited. Copyright @ 1996 by John Wiley & Sons, Ltd. All rights reserved.
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