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Lending Resumption After Default: Lessons from Capital Markets During the 19th Century

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  • Mr. Juan Sole

Abstract

This paper mines the experience of capital markets during the 19th century to propose an alternative way of interpreting international default episodes. The standard view is that defaulting on sovereign debt entails exclusion from capital markets. Yet we have observed multiple instances of sovereign debt default in which the reaction of lenders was not the one predicted by the punishment story: in some cases, lending ceased for long periods, but in others it was not interrupted. This paper claims that the reaction of lenders after default stems from the additional knowledge about the borrower that lenders acquire during these episodes. The lending relationship is modeled in a costly state-verification environment in which governments have private information about their investment projects (good or bad). It is shown that, in the event of default, it is worthwhile for lenders to find out more about the type of project, and then interrupt lending only if the project is believed to be a bad one.

Suggested Citation

  • Mr. Juan Sole, 2006. "Lending Resumption After Default: Lessons from Capital Markets During the 19th Century," IMF Working Papers 2006/176, International Monetary Fund.
    • Handle: RePEc:imf:imfwpa:2006/176
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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.
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    9. Peter H. Lindert & Peter J. Morton, 1989. "How Sovereign Debt Has Worked," NBER Chapters, in: Developing Country Debt and Economic Performance, Volume 1: The International Financial System, pages 39-106, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Jorge Guillen, 2010. "Financial Distress and Access to Capital in Emerging Markets," Prague Economic Papers, Prague University of Economics and Business, vol. 2010(1), pages 5-20.

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