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Rational Liquidity Crises in the Sovereign Debt Market: In Search of a Theory

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  • Ms. Enrica Detragiache

Abstract

This paper studies under what circumstances creditworthy sovereign borrowers may be denied liquidity by rational creditors. It is shown that, when the creditor side of the market consists of many small investors there may be multiple rational expectations equilibria. In one equilibrium, creditors’ pessimistic expectations about the borrower’s creditworthiness become self-fulfilling, and the borrower experiences a liquidity crisis. Multiple equilibria can be avoided by marketing the loan appropriately or by developing a reputation for following good policies. Liquidity problems can also arise because of the temporary disruption of international bond markets due to events unrelated to the borrower’s circumstances. Policies responses are discussed.

Suggested Citation

  • Ms. Enrica Detragiache, 1996. "Rational Liquidity Crises in the Sovereign Debt Market: In Search of a Theory," IMF Working Papers 1996/038, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:1996/038
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    Keywords

    WP; bond market; commercial paper; debtor country; loan contract; borrower issues bond; loan amount; self-fulfilling liquidity crises; Liquidity; Loans; Securities markets; Debt service;
    All these keywords.

    JEL classification:

    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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