Sean McCrary, José-Víctor Ríos-Rull and Adrien Wicht

Abstract: We study the role of lack commitment in shaping the allocations of the canonical incomplete markets sovereign default model of Eaton and Gersovitz (1981). We show how the equilibrium with commitment to the circumstances under which default can be undertaken involves a very different set of functional equations than in the equilibrium without commitment. It turns out that, in practice, under commitment default does not exist in all but very extreme quantitative environments. We document how the standard specification of Arellano (2008) displays no default if there is commitment, even in the absence of both utility cost and exclusion from borrowing. While less standard specifications can produce some default under commitment, we provide examples that demonstrate how rare default is. We interpret default as a recourse of last resort.

March 2023 - download.