HETEROGENEITY AND INTERTEMPORAL TRADE - FINDING SUPPORT FOR INTERNATIONAL CREDIT CONTRACTS

This paper examines the role heterogeneity plays in supporting interte mporal trades between countries when no legal contracts bind sovereign debtors. In a dynamic general equilibrium model, countries smooth con sumption over time by choosing optimal investment and bond sales or pu rchases. Countries which follow efficient investment plans and borrow with the intention of repaying debts may nevertheless find default to be in their best interest. Credit ceilings which eliminate default eli minate some if not all intertemporal trades. Positive credit ceilings arise only when there is sufficient intertemporal heterogeneity to ins ure that a country's future includes foreign and domestic investment.