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Unique equilibrium in the Eaton-Gersovitz model of sovereign debt

date Date: September 1, 2015
date Author(s): Adrien Auclert, Matthew Rognlie
date Affiliation: Princeton University - Stanford University

A common view of sovereign debt markets is that they are prone to multiple equilibria. We show that such multiplicity does not exist in the infinite-horizon model of Eaton and Gersovitz (1981), a widely adopted benchmark for quantitative analyses of these markets. When the value from government default is exogenous, the model features a unique Markov perfect equilibrium, which is also its unique subgame perfect equilibrium. We extend this uniqueness result to two alternative environments: one in which governments face a positive bound on the assets they can accumulate before default, and one in which they are allowed to re-access financial markets after default. Our proof is based on a replication argument similar to the one used by Bulow and Rogoff to show that debt cannot be sustained by reputation alone. An incomplete markets version of their result emerges as a special case of our uniqueness result.

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