DP12750 Sovereign Default: The Role of Expectations

Author(s): Ayres, Gaston Navarro, Juan Pablo Nicolini, Pedro Teles
Publication Date: February 2018
Keyword(s): good and bad times, multiple equilibria, sovereign default
JEL(s): E44, F34
Programme Areas: International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=12750

In the standard model of sovereign default, as in Aguiar and Gopinath (2006) or Arellano (2008), default is driven by fundamentals alone. There is no independent role for expectations. We show that small variations of that model are consistent with multiple interest rate equilibria, similar to the ones found in Calvo (1988). For distributions of output that are commonly used in the literature, the high interest rate equilibria have properties that make them fragile. Once output is drawn from a distribution with both good and bad times, however, it is possible to have robust high interest rate equilibria.