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

Author/Editor:

Juan Sole

Publication Date:

July 1, 2006

Electronic Access:

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Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary:

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.

Series:

Working Paper No. 06/176

Subject:

Frequency:

Bimonthly

English

Publication Date:

July 1, 2006

ISBN/ISSN:

9781451864366/1018-5941

Stock No:

WPIEA2006176

Format:

Paper

Pages:

28

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