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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.

Suggested Citation

  • Bernhard Paasche & Stanley E. Zin, 2001. "Competition and Intervention in Sovereign Debt Markets," NBER Working Papers 8679, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:8679 Note: IFM
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    File URL: http://www.nber.org/papers/w8679.pdf
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    References listed on IDEAS

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    1. Eaton, Jonathan & Fernandez, Raquel, 1995. "Sovereign debt," Handbook of International Economics,in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 3, pages 2031-2077 Elsevier.
    2. 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.
    3. Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 289-309.
    4. Mark V. Pauly, 1974. "Overinsurance and Public Provision of Insurance: The Roles of Moral Hazard and Adverse Selection," The Quarterly Journal of Economics, Oxford University Press, vol. 88(1), pages 44-62.
    5. Barry Eichengreen, 1991. "Historical Research on International Lending and Debt," Journal of Economic Perspectives, American Economic Association, vol. 5(2), pages 149-169, Spring.
    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. Lizarazo, Sandra Valentina, 2013. "Default risk and risk averse international investors," Journal of International Economics, Elsevier, vol. 89(2), pages 317-330.
    2. Saqib Jafarey & Sajal Lahiri, 2009. "Developing Country Borrowing From A Monopolistic Lender: Strategic Interactions And Endogenous Leadership," The Japanese Economic Review, Japanese Economic Association, vol. 60(2), pages 191-207.
    3. Nicolas Melissas, 2009. "On Bid Disclosure in OCS Wildcat Auctions," Working Papers 0905, Centro de Investigacion Economica, ITAM.
    4. Sandra Lizarazo & Jose Maria Da-Rocha, 2009. "Money, Credit and Default," Working Papers 0908, Centro de Investigacion Economica, ITAM.
    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.
    6. 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.

    More about this item

    JEL classification:

    • F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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