ramon marimon's discussion of "self-fulfilling debt crises, revisited: the art of...

DiscussionofMarkAguiar,SatyajitChatterjee, HaroldColeandZacharyStangebye(ACCS)’

Self-Ful(illingDebtCrises,Revisited: TheArtoftheDesperateDeal

byRamonMarimonEuropeanUniversityInstituteandUPF–BarcelonaGSE,

andCEPR&NBER

Cambridge,September2,2016

For Good and for Bad:

For Good and for Bad: a follow-up of Hal &Tim (CK)’“Self-Fulfilling Debt Crises”

C&K

CK: building on the work of an imaginative economist !

The imaginative economist:

ACCS also build on the work of the Debt Repudiation pioneers

The Debt Repudiation pioneers: E&G

This paper:

Shows that debt markets with (CK) and (EG) features can be made more efficient

by enlarging the contracting possibilities with ‘Desparate Deal’ debt auctions

(resembling some euro crisis deals).

Five Points:

Five Points:

Point 1:

Point 2:

Point 3:

Point 4:

Point 5:

ACCS vs. CK

• The economy:

– An incomplete markets endowment economy.

– An incomplete markets economy with capital accumulation.

• The players:

– Infinitely lived consumers, (risk neutral) bankers and a benevolent (uncommitted)

government

– An infinitely lived benevolent (uncommitted) government and short-lived (risk-averse,

limited-wealth) lenders

• The financial markets:

– One-period non-contingent defaultable bonds (+ capital).

– Long-term non-contingent defaultable bonds (+ risk-free asset).

• The state ((the real stuff), the bonds, the sunspot):

– s = ((K, a), B, ζ).

– s = ((Y, g, z), B, ρ).

ACCS vs. CK

• The ‘rollover crises’

– One-period debt is prompt to them

– Long-term debt can be managed to prevent them; however, ACCS rollover all the

debt each period!

• The theory

– Propositions 1 to 6.

– Proposition... (none)

• The evidence and calibration

– They talk about Mexico but they calibrate to nowhere

– They talk about Portugal and they calibrate to Mexico

• But a key difference can be seen in the different role of...

Crisis Zone & Bond prices

C(K,π) ≡ {s ∈ S | default is optimal if q = 0 but q > 0 is possible}

In C(K,π) the ‘sunspot’, ζ, coordinates lender’s beliefs (outside C(K,π), ζ is irrelevant).

In the Self-Fulfilling equilibrium:

Subjective prob. of, within the period, ex-post default =

{1 if 0 ≤ ζ ≤ π0 if π < ζ ≤ 1

The government chooses a pure-strategy unconditional on the ‘sunspot’ realisation.

q(s,B′) =

β if in no-crisis zone and D(s,B′) = 0

β(1− π) if in crisis zone and D(s,B′) = 0

0 if in default zone; i.e., D(s,B′) = 1

Crisis Zone

C ≡ {s ∈ S | default is optimal if q = 0 but q > 0 is possible}

C ≡{s ∈ S | max

b′≤(1−λ)bVR(s,B

′) ≤ V D

(s) and maxb′≥(1−λ)b

VR(s,B

′) ≥ V D

(s)

}

• s ∈ C only if s is a bad time: if debt is high and endowment is low!

• The sunspot ρ is an indicator of ‘the zone’ : ρ = rV (vulnerable) or ρ = rC (crisis).

Crisis Zone & Bond prices

q(s,B′) =

(1−D(s,B′))qEG(s,B′) if ρ = rV or s /∈ CqD(s,B′) if ρ = rC and s ∈ C and qD(s,B′) ≤ qEG(s,B′)0 otherwise

u(Y − (r

∗+ λ)B + q

D(s,B

′)(B

′ − (1− λ)B))+βE

[V (s

′) | s,B′

]= V

D(s)

The government is indifferent between defaulting and issuing (B′ − (1 − λ)B) > 0 at

qD(s,B′) > 0. It randomizes D(s,B′) between the two and in equilibrium risk-averse

lenders are indifferent between buying ‘desperate deal’ bonds and the risk-free asset.

Point 1: On the different role of ‘Crisis Zones’ & ‘Sunspots’

Point 2: On the ‘learnability of sunspots’ &‘Sovereign Bond Auctions’

• Social coordination norms – such as traffic lights – I would not call them sunspots

• Neither CK nor ACCS sunspots – ζ and ρ, respectively – are social coordination norms.

How do they arise as coordinators of beliefs?

• Experimental evidence does not support (out-of-the-blue) sunspots (MSS et al.).

• ζ is a pure belief coordinator, but strategies are simple (easier to learn).

• ρ is associated to ‘real factors’, but mixed-strategy equilibria are not simple (difficult

to learn);

Point 2: On the ‘learnability of sunspots’ &‘Sovereign Bond Auctions’

• Social coordination norms – such as traffic lights – I would not call them sunspots

• Neither CK nor ACCS sunspots – ζ and ρ, respectively – are social coordination norms.

How do they arise as coordinators of beliefs?

• Experimental evidence does not support (out-of-the-blue) sunspots (MSS et al.).

• ζ is a pure belief coordinator, but strategies are simple (easier to learn).

• ρ is associated to ‘real factors’, but mixed-strategy equilibria are not simple (difficult

to learn); however...

• Auctions provide a great deal of information (making learning easier);

• in particular, when the supplier sets the terms (qD(s,B′))

Point 2: On the ‘learnability of sunspots’ &‘Sovereign Bond Auctions’

• Social coordination norms – such as traffic lights – I would not call them sunspots

• Neither CK nor ACCS sunspots – ζ and ρ, respectively – are social coordination norms.

How do they arise as coordinators of beliefs?

• Experimental evidence does not support (out-of-the-blue) sunspots (MSS et al.).

• ζ is a pure belief coordinator, but strategies are simple (easier to learn).

• ρ is associated to ‘real factors’, but mixed-strategy equilibria are not simple (difficult

to learn); however...

• Auctions provide a great deal of information (making learning easier);

• in particular, when the supplier sets the terms (qD(s,B′))

• (unfortunately the paper is mute about its Debt Auctions)

Point 3:

GET RID OF…

Point 4: On the value of ‘Desperate Deals’

Point 4: On the value of ‘Desperate Deals’

• As ACCS explain ‘Desperate Deals’ are socially valuable:

– “reduces the deadweight loss associated with rollover crises ”

– enhances the efficiency of financial markets by enlarging their lending capacity

Point 4: On the value of ‘Desperate Deals’

• As ACCS explain ‘Desperate Deals’ are socially valuable:

– “reduces the deadweight loss associated with rollover crises”

– enhances the efficiency of financial markets by enlarging their lending capacity...

– the ex-ante value to the benevolent government is higher

Point 4: On the value of ‘Desperate Deals’

• As ACCS explain ‘Desperate Deals’ are socially valuable:

– “reduces the deadweight loss associated with rollover crises”

– enhances the efficiency of financial markets by enlarging their lending capacity...

– the ex-ante value to the benevolent government is higher, but...

• “As a rule, the gain is less than one-half of one percent”

Point 4: On the value of ‘Desperate Deals’

• As ACCS explain ‘Desperate Deals’ are socially valuable:

– “reduces the deadweight loss associated with rollover crises”

– enhances the efficiency of financial markets by enlarging their lending capacity...

– the ex-ante value to the benevolent government is higher, but...

• “As a rule, the gain is less than one-half of one percent”

• However, they may be larger when

– labour and/ or capital accumulation decisions – as in CK – are taken into account.

– lenders are heterogeneous (in ACCS risk-aversion & limited wealth helps)

– well documented, contagion effects are accounted for.

– agents form the expectations through learning...

Point 5: On ‘Self-Confirming Equilibria’ vs. ‘Self-Fulfilling Equilibria’

Point 5: On ‘Self-Confirming Equilibria’ vs. ‘Self-Fulfilling Equilibria’

• Self-Fulfilling Equilibria (SFE) are Rational Expectations Equilibria (REE).

• SCE satisfy Subjective Rationality in equilibrium (i.e. REE ⊂ SCE).

• While the SCE equilibrium set is, in general, larger, learning processes converge to SCE

(Fudenberg & Levine et al.). Learnable SCE may exclude many REE (and SFE).

Point 5: On ‘Self-Confirming Equilibria’ vs. ‘Self-Fulfilling Equilibria’

• Self-Fulfilling Equilibria (SFE) are Rational Expectations Equilibria (REE).

• SCE satisfy Subjective Rationality in equilibrium (i.e. REE ⊂ SCE).

• While the SCE equilibrium set is, in general, larger, learning processes converge to SCE

(Fudenberg & Levine et al.). Learnable SCE may exclude many REE (and SFE).

• A SCE is not a REE if, and only if, by making an out-of-equlibrium move an agent’s

subjective beliefs are contradicted.

• Within the ACCS model CK equilibria are Self-Fulfilling, but...

Point 5: On ‘Self-Confirming Equilibria’ vs. ‘Self-Fulfilling Equilibria’

• Self-Fulfilling Equilibria (SFE) are Rational Expectations Equilibria (REE).

• SCE satisfy Subjective Rationality in equilibrium (i.e. REE ⊂ SCE).

• While the SCE equilibrium set is, in general, larger, learning processes converge to SCE

(Fudenberg & Levine et al.). Learnable SCE may exclude many REE (and SFE).

• A SCE is not a REE if, and only if, by making an out-of-equlibrium move an agent’s

subjective beliefs are contradicted.

• Within the ACCS model CK equilibria are Self-Fulfilling, but...

• A (non-committed) benevolent Government who can auction ‘Desperate Deals’makes (all?) CK default equilibria to become non-REE Self-Confirming Equilibria(with some ‘absolute continuity of beliefs assumption’)

Point 5: On ‘Self-Confirming Equilibria’ vs. ‘Self-Fulfilling Equilibria’

• Self-Fulfilling Equilibria (SFE) are Rational Expectations Equilibria (REE).

• SCE satisfy Subjective Rationality in equilibrium (i.e. REE ⊂ SCE).

• While the SCE equilibrium set is, in general, larger, learning processes converge to SCE

(Fudenberg & Levine et al.). Learnable SCE may exclude many REE (and SFE).

• A SCE is not a REE if, and only if, by making an out-of-equlibrium move an agent’s

subjective beliefs are contradicted.

• Within the ACCS model CK equilibria are Self-Fulfilling, but...

• A (non-committed) benevolent Government who can auction ‘Desperate Deals’makes (all?) CK default equilibria to become non-REE Self-Confirming Equilibria(with some ‘absolute continuity of beliefs assumption’)

• Therefore, social experimentation by the government, with ‘Desperate Deals,’will eliminate (all?) these non-REE SCE !!!

Point 5: On ‘Self-Confirming Equilibria’ vs. ‘Self-Fulfilling Equilibria’

• Self-Fulfilling Equilibria (SFE) are Rational Expectations Equilibria (REE).

• SCE satisfy Subjective Rationality in equilibrium (i.e. REE ⊂ SCE).

• While the SCE equilibrium set is, in general, larger, learning processes converge to SCE

(Fudenberg & Levine et al.). Learnable SCE may exclude many REE (and SFE).

• A SCE is not a REE if, and only if, by making an out-of-equlibrium move an agent’s

subjective beliefs are contradicted.

• Within the ACCS model CK equilibria are Self-Fulfilling, but...

• A (non-committed) benevolent Government who can auction ‘Desperate Deals’makes (all?) CK default equilibria to become non-REE Self-Confirming Equilibria(with some ‘absolute continuity of beliefs assumption’)

• Therefore, social experimentation by the government, with ‘Desperate Deals,’will eliminate (all?) these non-REE SCE !!!

• You can call it Ramon’s conjecture...

Five Points on a great paper:

Point 1: ACCS builds on – but substantially departs from – CK (not just on ‘Desperate

Deals’)

Point 2: Sunspots SFE may not be learnable, but Sovereign Bond Auctions provide a

great deal of information.

Point 3: Let’s get rid of sunspots!

Point 4: ‘Desperate Deals’ are possibly more valuable than what ACCS claim!

Point 5: ‘Desperate Deals’ can transform CK default Self-Fulfilling Equilibria into non-

REE Self-Confirming Equilibria, which are easy to dispel!!

Thanks!