Xavier Mateos-Planas, Sean McCrary, José-Víctor Ríos-Rull, Adrien Wicht (2025). Commitment in the canonical sovereign default model
In: Journal of International Economics

Abstract

We study the role of lack of commitment in the canonical incomplete-markets sovereign default model of Eaton and Gersovitz (1981). We show the very different set of functional equations that appear under commitment relative to the standard ones. We document how in the standard yearly specification of Arellano (2008) with short-term debt there is no default if there is commitment to the circumstances of when to default. A bad enough disaster makes default under commitment appear. In contrast, with long-term debt, in the standard quarterly Chatterjee and Eyigungor (2012) environment commitment only to one-period-ahead default barely changes the no-commitment allocation, but commitment to both the one-period-ahead default circumstances and the one-period-ahead dilution, or commitment to a longer horizon (a year or a bit more), eliminates default completely and is equivalent to commitment in the one-period-ahead default with short-term debt.

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