A Continuous Time Model of Sovereign Debt

Reputation and Sovereign Default

Econometrica ◽

10.3982/ecta16685 ◽

2021 ◽

Vol 89 (4) ◽

pp. 1979-2010 ◽

Cited By ~ 1

Author(s):

Manuel Amador ◽

Christopher Phelan

Keyword(s):

Continuous Time ◽

Sovereign Debt ◽

Sovereign Default ◽

Bond Price ◽

Continuous Time Model ◽

Bond Prices ◽

Time Model ◽

Markov Equilibrium ◽

Random Times ◽

Increasing Functions

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 commitment type, which cannot default, and an opportunistic type, which can, and where we assume outside lenders have particular beliefs regarding how a commitment type should borrow for any given level of debt and bond price. In any Markov equilibrium, the opportunistic type mimics the commitment type when borrowing, revealing its type only by defaulting on its debt at random times. The equilibrium features a “graduation date”: a finite amount of time since the last default, after which time reputation reaches its highest level and is unaffected by not defaulting. Before such date, not defaulting always increases the country's reputation. For countries that have recently defaulted, bond prices and the total amount of debt are increasing functions of the amount of time since the country's last default. For countries that have not recently defaulted (i.e., those that have graduated), bond prices are constant.

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Sovereign Debt Booms in Monetary Unions

The American Economic Review ◽

10.1257/aer.104.5.101 ◽

2014 ◽

Vol 104 (5) ◽

pp. 101-106 ◽

Cited By ~ 10

Author(s):

Mark Aguiar ◽

Manuel Amador ◽

Emmanuel Farhi ◽

Gita Gopinath

Keyword(s):

Continuous Time ◽

Sovereign Debt ◽

Currency Union ◽

Monetary Unions ◽

Continuous Time Model ◽

Time Model ◽

Debt Accumulation ◽

Debt Dynamics ◽

Real Value ◽

The Impact

We propose a continuous time model to investigate the impact of inflation credibility on sovereign debt dynamics. At every point in time, an impatient government decides fiscal surplus and inflation, without commitment. Inflation is costly, but reduces the real value of outstanding nominal debt. In equilibrium, debt dynamics is the result of two opposing forces: (i) impatience and (ii) the desire to conquer low inflation. A large increase in inflation credibility can trigger a process of debt accumulation. This rationalizes the sovereign debt booms that are often experienced by low inflation credibility countries upon joining a currency union.

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