Rational Liquidity Crises in the Sovereign Debt Market: In Search of a Theory

Author/Editor:

Enrica Detragiache

Publication Date:

April 1, 1996

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 studies under what circumstances creditworthy sovereign borrowers may be denied liquidity by rational creditors. It is shown that, when the creditor side of the market consists of many small investors there may be multiple rational expectations equilibria. In one equilibrium, creditors’ pessimistic expectations about the borrower’s creditworthiness become self-fulfilling, and the borrower experiences a liquidity crisis. Multiple equilibria can be avoided by marketing the loan appropriately or by developing a reputation for following good policies. Liquidity problems can also arise because of the temporary disruption of international bond markets due to events unrelated to the borrower’s circumstances. Policies responses are discussed.

Series:

Working Paper No. 1996/038

Subject:

Asset and liability management Debt service External debt Financial crises Financial institutions Financial markets Liquidity Loans Securities markets

Notes:

Also published in Staff Papers, Vol. 43, No. 3, September 1996.

English

Publication Date:

April 1, 1996

ISBN/ISSN:

9781451845648/1018-5941

Stock No:

WPIEA0381996

Pages:

32

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