A contraction for sovereign debt models

Mark Aguiar, Manuel Amador

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Abstract

Using a dual representation, we show that the Markov equilibria of the one-period-bond Eaton and Gersovitz (1981) incomplete markets sovereign debt model can be represented as a fixed point of a contraction mapping, providing a new proof of the uniqueness and existence of equilibrium in the benchmark sovereign debt model. The arguments can be extended to incorporate re-entry probabilities after default when the shock process is iid. Our representation of the equilibrium bears many similarities to an optimal contracting problem. We use this to argue that commitment to budget rules has no value to a benevolent government. We show how the introduction of long-term bonds breaks the link to the constrained planning problem.

Original languageEnglish (US)
Pages (from-to)842-875
Number of pages34
JournalJournal of Economic Theory
Volume183
DOIs
StatePublished - Sep 2019

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Keywords

  • Eaton-Gersovitz
  • Existence of equilibria
  • One period bonds
  • Sovereign debt
  • Time-consistency
  • Uniqueness of equilibria

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