Self-fulfilling crises with default and devaluation (Q361822)

The paper suggests a dynamic stochastic general equilibrium model (with discrete time) of defaults and devaluations in which self-fulfilling crises can arise. There are three types of agents in the economy: a continuum of identical consumers who invest (in domestic capital and in foreign securities), and pay taxes, a continuum of international bankers, and a government. The representative consumer's utility function is the expected infinite sum (on periods) of weighted sums of private and public consumptions. The individual banker's utility function is the expected infinite sum of weighted private consumptions. The governments object is to maximize the welfare of consumers. In every period the government chooses the level of government consumption and the real exchange rate, decides whether or not to default on its old debt, and sells debt. The bankers within each period choose to buy or not the debt. In each period, the value of an exogenous ``sunspot'' random factor is realized. The agents' decisions are defined via their value functions which are stochastic Bellman-type functions. These functions also define equilibrium of the economy. The equilibria existence and their properties at different assumptions are investigated. Theoretical results are demonstrated on character of the crisis in Argentina in 2001--2002.