A GAME THEORETICAL APPROACH TO THE INTERNATIONAL DEBT OVERHANG

We consider an international financial problem called debt overhang, b y which we mean a situation where a sovereign country has borrowed mon ey from foreign banks and has been unable to fulfill the scheduled rep ayments for some period. The problem is formulated as a noncooperative game with n lender banks as players where each decides either to sell its loan exposure to the debtor country at the present price of debt on the secondary market, or to wait and keep its exposure. This game h as many pure and mixed strategy Nash equilibria. We show, however, tha t in any Nash equilibrium, the resulting secondary market price remain s almost the same as the present price for a large number of banks. We also obtain the comparative statics result that in a mixed strategy e quilibrium, a bank with a smaller loan exposure has a greater tendency to sell than one with a larger loan exposure. We discuss the implicat ions of these results for the functioning of the secondary market and the resolution of debt overhang.