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Sovereign Debt, Reputation and Credit Terms

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  • Eaton, Jonathan

Abstract

This paper develops a model in which sovereign debtors repay debt in order to maintain a reputation for repayment. Repayment gives creditors reason to think that the debtor will suffer adverse consequences if the debtor defaults, so they continue to lend. I compare a situation in which competitive lenders earn zero profit on each loan with one in which they can make long-term commitments to individual borrowers, so that the zero-profit condition applies only in the long run. In many circumstances, a borrower benefits ex ante if lenders commit to denying credit to a borrower in default even if, at that point, a subsequent loan is profitable. Furthermore, a "debt overhang," while possibly altering credit terms, does not cause profitable investment opportunities to go unexploited. Copyright @ 1996 by John Wiley & Sons, Ltd. All rights reserved.

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  • Eaton, Jonathan, 1996. "Sovereign Debt, Reputation and Credit Terms," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 1(1), pages 25-35, January.
    • Handle: RePEc:ijf:ijfiec:v:1:y:1996:i:1:p:25-35
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    1. Cole, Harold L & Dow, James & English, William B, 1995. "Default, Settlement, and Signalling: Lending Resumption in a Reputational Model of Sovereign Debt," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 36(2), pages 365-385, May.
    2. Grossman, Herschel I & Van Huyck, John B, 1988. "Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation," American Economic Review, American Economic Association, vol. 78(5), pages 1088-1097, December.
    3. Jonathan Eaton & Mark Gersovitz & Joseph E. Stiglitz, 1991. "The Pure Theory of Country Risk," NBER Chapters, in: International Volatility and Economic Growth: The First Ten Years of The International Seminar on Macroeconomics, pages 391-435, National Bureau of Economic Research, Inc.
    4. Bulow, Jeremy & Rogoff, Kenneth, 1989. "Sovereign Debt: Is to Forgive to Forget?," American Economic Review, American Economic Association, vol. 79(1), pages 43-50, March.
    5. Atkeson, Andrew, 1991. "International Lending with Moral Hazard and Risk of Repudiation," Econometrica, Econometric Society, vol. 59(4), pages 1069-1089, July.
    6. Timothy J. Kehoe & David K. Levine, 1993. "Debt-Constrained Asset Markets," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 60(4), pages 865-888.
    7. Stiglitz, Joseph E & Weiss, Andrew, 1983. "Incentive Effects of Terminations: Applications to the Credit and Labor Markets," American Economic Review, American Economic Association, vol. 73(5), pages 912-927, December.
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