Self-Fulfilling Debt Dilution: Maturity and Multiplicity in Debt Models

Mark Aguiar, Manuel Amador

Research output: Contribution to journalArticle

Abstract

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. 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.

Original languageEnglish (US)
Pages (from-to)2783-2818
Number of pages36
JournalAmerican Economic Review
Volume110
Issue number9
DOIs
StatePublished - Sep 2020

All Science Journal Classification (ASJC) codes

  • Economics and Econometrics

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