THE STRUCTURE OF COMPETITIVE EQUILIBRIUM WITH UNSECURED DEBT

I provide a complete characterization of equilibrium with risk of default in sequential economies under uncertainty. Default induces permanent exclusion from financial markets and not-too-tight solvency constraints prevent debt repudiation at equilibrium. The method of analysis relies on a recursive planning program along with the theory of monotone concave opera- tors. The reputational mechanism is fragile, as it sustains constrained efficient as well as constrained inefficient equilibria. Constrained inefficient equilibria involve a progressive deterioration of reputation, inducing a collapse of financial markets with positive probability. Importantly, the only ergodic recursive equilibria (involving trade) are constrained efficient.