Self-Fulfilling Debt Dilution: Maturity and Multiplicity in Debt Models / Mark A. Aguiar, Manuel Amador.

Format:

Book

Author/Creator:

Aguiar, Mark A.

Contributor:

National Bureau of Economic Research.

Amador, Manuel.

Series:

Working Paper Series (National Bureau of Economic Research) no. w24683.

NBER working paper series no. w24683

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

Self-Fulfilling Debt Dilution

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2018.

Summary:

We establish that creditor beliefs regarding future borrowing can be self-fulfilling, leading to multiple equilibria with markedly different debt accumulation patterns. We characterize such indeterminacy in the Eaton-Gersovitz sovereign debt model augmented with long maturity bonds. Two necessary conditions for the multiplicity are: (i) the government is more impatient than foreign creditors, and (ii) there are deadweight losses from default; both are realistic and standard assumptions in the quantitative literature. The multiplicity is dynamic and stems from the self-fulfilling beliefs of how future creditors will price bonds; long maturity bonds are therefore a crucial component of the multiplicity. We introduce a third party with deep pockets to discuss the policy implications of this source of multiplicity and identify the potentially perverse consequences of traditional "lender of last resort" policies.

Notes:

Print version record

June 2018.