Discussion paper
DP12750 Sovereign Default: The Role of Expectations
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.
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