A Constant Recontracting Model of Sovereign Debt

Abstract

We present a dynamic model of international lending in which borrowers cannot commit to future repayments and in which debtors can sometimes successfully negotiate partial defaults or "rescheduling agreements." All parties in a debt rescheduling negotiation realize that today's rescheduling agreement may itself have to be renegotiated in the future. Our bargaining-theoretic approach allows us to handle the effects of uncertainty on sovereign debt contracts in a much more satisfactory way than in earlier analyses. The framework is readily extended to analyze the conflicting interests of different lenders and of banks and creditor country taxpayers.

Sovereign Theft: Theory and Evidence about Sovereign Default and Expropriation

“…Kaletsky (1985) and Bulow and Rogo¤ (1989a) suggest that sovereign theft could trigger direct sanctions, such as trade embargoes or gunboat diplomacy. Rose (2005) …nds that countries that defaulted on their debts experienced a decline in foreign trade, perhaps because creditors were imposing trade sanctions.…”

Sovereign default and debt renegotiation

“…5 Fernandez and Rosenthal (1990) analyze debt renegotiation through which the borrowing country gains improved future access to capital markets. Bulow and Rogoff (1989b) present a dynamic bargaining model tial repayment of defaulted debt after debt renegotiation. In our model debt recovery rates are endogenously determined in a Nash bargaining game and have an analytically characterization.…”

Government's credit-rating concerns and the evaluation of public projects

“…A second interpretation of the model, which can also applied to large countries, is of a closed economy in which the government discounts the future at a higher rate than its citizens and displays a preference for supplying government goods over private consumption. 2 2 The heavier discounting by the government can be the result of, for example, the uncertainty as to whether it will remain in power in the second period (as in Bulow and Rogo¤ (1989a)). A preference for supplying public goods can be due to the positive e¤ect on the probability of being re-elected, to direct rents extracted from running a large government (empire-building) and so on.…”