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Reputation and Sovereign Default

Author

Listed:
  • Christopher Phelan

    (University of Minnesota)

  • Manuel Amador

    (University of Minnesota and Federal Reserve Bank of Minneapolis)

Abstract

This paper presents a continuous time model of sovereign debt. In it, a relatively impatient sovereign government's hidden type switches back and forth between a behavioral type which cannot default and follows a set rule governing its borrowing as a function of its current debt and the price at which it can issue additional bonds, and an optimizing type which can default on the country’s debt at any time. We show that in the unique Markov perfect equilibrium, the optimizing type mimics the behavioral type when borrowing, revealing its type only by defaulting on its debt at random times. The Markov perfect equilibrium (the solution to a simple pair of ordinary differential equations) displays positive gross issuances at all dates, constant net imports as long as there is a positive equilibrium probability the government is the optimizing type, and net debt repayment only by the behavioral type. For countries which have recently defaulted, the interest rate the country pays on its debt is a decreasing function of the amount of time since its last default, its total debt is an increasing function of the amount of time since its last default, and the yield curve on its debt is downward sloping. For countries which have not recently defaulted, interest rates are constant and yield curves are flat.

Suggested Citation

  • Christopher Phelan & Manuel Amador, 2017. "Reputation and Sovereign Default," 2017 Meeting Papers 1167, Society for Economic Dynamics.
  • Handle: RePEc:red:sed017:1167
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    Cited by:

    1. Stangebye, Zachary R., 2020. "Beliefs and long-maturity sovereign debt," Journal of International Economics, Elsevier, vol. 127(C).
    2. Leonardo Martinez & Francisco Roch & Francisco Roldán & Jeromin Zettelmeyer, 2023. "Sovereign debt," Chapters, in: Refet S. Gürkaynak & Jonathan H. Wright (ed.), Research Handbook of Financial Markets, chapter 17, pages 378-405, Edward Elgar Publishing.
      • Leonardo Martinez & Francisco Roch & Francisco Roldan & Jeromin Zettelmeyer, 2022. "Sovereign Debt," Working Papers 167, Red Nacional de Investigadores en Economía (RedNIE).
      • Mr. Leonardo Martinez & Mr. Francisco Roch & Francisco Roldán & Mr. Jeromin Zettelmeyer, 2022. "Sovereign Debt," IMF Working Papers 2022/122, International Monetary Fund.
    3. Mark Aguiar & Manuel Amador & Stelios Fourakis, 2020. "On the Welfare Losses from External Sovereign Borrowing," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 68(1), pages 163-194, March.
    4. Satyajit c & Dean Corbae & Kyle Dempsey & Jose-Victor Rios-Rull, 2020. "A Quantitative Theory of the Credit Score," PIER Working Paper Archive 20-030, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.

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    JEL classification:

    • F3 - International Economics - - International Finance
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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