The risk of repudiation plays a central role in the size and nature of international capital flows. In this paper the author addresses the question of whether, in a world of international capital flows with risk of default, strategic externalities provide a rationale for regulation of international borrowing. The author models centralized arrangements of international debt in which only governments borrow and lend internationally and decentralized arrangements in which individuals have access to international markets. The author shows that a centralized setup allows more international risk sharing than a decentralized setup.
JEL classification: F34, F41
Key words: foreign debt, risk of default, capital controls
The author thanks Andrew Atkeson, Timothy Kehoe, Dirk Krueger, and Edward Prescott for helpful comments. The views expressed here are the author’s and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the author’s responsibility.
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