A Model of Lending Resumption after Default: Lessons from Capital Markets during the Nineteenth Century
This paper mines the experience of the nineteenth-century capital markets to propose an alternative interpretation of international defaults. The standard view-that sovereign default entails exclusion from markets-was often contradicted by reality: in some cases lending ceased, but in others it continued. This paper claims that lenders' responses to default stem from the additional knowledge about borrowers that is acquired during default episodes. Lending is modelled in a costly-state-verification environment where sovereigns have private information about their investment projects (good or bad). After default, lenders audit projects and interrupt lending only if the project is believed to be a 'bad' one. Copyright (c) The London School of Economics and Political Science 2008.
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