Research

Publication:

“Equilibrium Default Cycles,” 2007, joint with Balázs Szentes,
Journal of Political Economy, Vol. 115, No. 3 (June): pp. 403-446. 

Abstract. This paper analyzes Markov equilibria in a model of strategic lending in which (i) agents cannot commit to long-term contracts, (ii) contracts are incomplete, and (iii) incumbent lenders can coordinate their actions. Default cycles occur endogenously over time along every equilibrium path. After a sequence of bad shocks, the borrower in a competitive market accumulates debt so large that the incumbent lenders exercise monopoly power. Even though the incumbents could maintain this power forever, they find it profitable to let the borrower regain access to the competitive market after a sequence of good shocks. Equilibria are computed numerically, and their attributes are qualitatively consistent with numerous known empirical facts on sovereign lending. In addition, the model predicts that a borrower who accumulates debt overhang will regain access to the competitive credit market only after good shocks. This prediction is shown to be consistent with data on emerging market economies.

Other Papers:

“Debt Contracts with Short-Term Commitment,” November 2007 (Job Market paper)

Abstract. This paper analyzes the role of short-term commitment by the lender in a dynamic relationship where the borrower cannot be legally forced to make repayments. I show that short-term commitment can decrease social welfare compared to both the full and no-commitment cases considered by most of the literature. I show that the size of investment is positively related to the borrower's income. In addition, both underinvestment and overinvestment can occur in equilibrium. I also introduce the borrower's outside option and do comparative statics with respect to it. I show that the social welfare is non-monotonic in the borrower's outside option. If the borrower's outside option is interpreted as a measure of competitiveness of the credit market, this implies that an increase in the strength of competition has an ambiguous effect on welfare. Furthermore, numerical results suggest that as the outside option of the borrower increases, the renegotiation-proof equilibria converge to the Markov equilibrium, where the agents' strategies depend only on the borrower's liquidity. That is, the welfare gain from using complicated history-dependent strategies instead of simple Markov strategies is small when the borrower's outside option is high.

“Specialization under Uncertainty,” May 2004, joint with Andrei Kovrijnykh

Abstract. We analyze a general equilibrium model with two sectors, sector-specific skills, and stochastic sector-specific productivity shocks. The main focus of this paper is the choice of specialization by the workers. That is: How much sector-specific human capital should a worker acquire? We identify three reasons for less than perfect specialization: 1) risk-aversion, 2) decreasing returns in human capital accumulation, and 3) substitutability/complementarity between outputs. For a simple distribution of shocks, where the realization of the shocks can take one of two values and the shocks are perfectly negatively correlated, we show that there are always some workers who fully specialize in a competitive equilibrium. Furthermore, if the productivity shocks have large enough variance, there will be some workers who acquire both skills. We prove that the competitive equilibrium is generally inefficient, and generates too little specialization compared to the social optimum where the social planner can use transfers among the workers. We also argue that if the planner is not allowed to use these transfers, there will be less specialization in this constrained optimal outcome than in the competitive equilibrium. In order to see how the correlation between the productivity shocks affects the specialization by the workers, we compute the equilibrium skill distribution numerically.

Last modified 07/2008