THE ROLE OF MULTILATERAL INSTITUTIONS IN THE MARKET FOR SOVEREIGN DEBT

Creditor country governments have an interest in avoiding defaults by sovereign debtors, because default sanctions may be costly to their ci tizens. As a result, a standard bargaining model predicts that debtors do not repay in equilibrium, even if the threat of sanctions is credi ble on the part of the banks. By contracting with a third party, such as a multilateral institution with some degree of independence, credit or country governments can precommit not to intervene. In equilibrium, when debt renegotiation occurs, the sovereign receives a subsidy from the multitateral agency. The model is used to interpret recent debt r eduction operations.