Journal Article

Sovereign Debt without Default Penalties

Alexander Guembel and Oren Sussman

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 76, issue 4, pages 1297-1320
Published in print October 2009 | ISSN: 0034-6527
Published online October 2009 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/j.1467-937X.2009.00542.x
Sovereign Debt without Default Penalties

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We develop a theory of sovereign borrowing where default penalties are not implementable. We show that when debt is held by both domestic and foreign agents, the median voter might have an interest in serving it. Our theory has important practical implications regarding (a) the role of financial intermediaries in sovereign lending, (b) the effect of capital flows on price volatility including the possible overvaluation of debt to the point that the median voter is priced out of the market, and (c) debt restructuring where creditors are highly dispersed.

Keywords: F34

Journal Article.  11420 words.  Illustrated.

Subjects: International Finance

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