A SELF-FULFILLING MODEL OF MEXICO 1994-1995 DEBT CRISIS

This paper explores the extent to which the Mexican government's inabi lity to roll over its debt during December 1994 and January 1995 can b e modeled as a self-fulfilling debt crisis. In the model there is a cr ucial interval of debt for which the government, although it finds it optimal to repay old debt if it can sell new debt, finds it optimal to default if it cannot sell new debt. If government debt is in this int erval, which we call the crisis zone, then we can construct equilibria in which a crisis can occur stochastically, depending on the realizat ion of a sunspot variable. The size of this zone depends on the averag e length of maturity of government debt. Our analysis suggests that fo r a country, like Mexico, with a very shea maturity structure of debt, the crisis zone is large and includes levels of debt as low as those in Mexico before the crisis.