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Self-Fulfilling Debt Dilution: Maturity and Multiplicity in Debt Models
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; both are realistic and standard assumptions in the quantitative literature. The multiplicity is dynamic and stems from the self-fulfilling beliefs of ...
Working Paper
A seniority arrangement for sovereign debt
A sovereign's inability to commit to a course of action regarding future borrowing and default behavior makes long-term debt costly (the problem of debt dilution). One mechanism to mitigate the debt dilution problem is the inclusion of a seniority clause in sovereign debt contracts. In the event of default, creditors are to be paid off in the order in which they lent (the ?absolute priority" or ?first-in-time" rule). In this paper, we propose a modification of the absolute priority rule that is more suited to the sovereign debt context and analyze its positive and normative implications ...
Working Paper
Building Credit History with Heterogeneously Informed Lenders
This paper examines a novel mechanism of credit-history building as a way of aggregating information across multiple lenders. We build a dynamic model with multiple competing lenders, who have heterogeneous private information about a consumer's creditworthiness, and extend credit over multiple stages. Acquiring a loan at an early stage serves as a positive signal | it allows the borrower to convey to other lenders the existence of a positively informed lender (advancing that early loan) | thereby convincing other lenders to extend further credit in future stages. This signaling may be costly ...