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Mr. Heipman is the Archie Sherman Professor of International Economic Relations at Tel Aviv University. He is a graduate of Tel Aviv University and Harvard University. Part of the work for this paper was done while the author was a Visiting Scholar in the Research Department of the Fund and part while he was a Visiting Professor at the Massachusetts Institute of Technology. He thanks Gene Grossman, Paul Krugman, Assaf Razin, Jeffrey Sachs, Lars Svens-son, and his colleagues in the Fund for helpful comments and discussions.
In this example the following parameters and functions are used: R — 1, t = 0.5, θ is uniformly distributed on [0,1], and E(I) = 1 - 10 log 0.27+ 10 log (0.27 + 0.1I).
It is easy to add a domestic bond market to the model. In the absence of capital movements, however, this market has to clear at zero indebtedness. Consequently, the following analysis would not be affected by this modification. In fact, one can calculate from what follows the equilibrium interest rate on this bond market.
Estimates of relative risk aversion are typically larger than unity. In linear regressions of the ratio of investment to gross domestic product (GDP) on the deht-GDP ratio for the 15 most heavily indebted countries, I found only in 8 of them a negative coefficient that is significantly different from zero (the sample period was 1973 to 1986 or 1987).
Changes in debt and investment change the critical state 9. Changes in the critical state, however, have second-order effeas (because the rate-of-return function is continuous despite the fact that its derivatives are not) and are therefore disregarded in this formula.
In the presence of free capital mobility, the country may be trading additional assets. My results do not change as long as the price of these assets is not influenced by either debt or investment.
Proof From Proposition 3, on the one hand, it is known that under these circumstances debt forgiveness depresses investment. On the other hand,
The curves in Figure 9 were simulated from the following data: R = 1, t = ½ G(θ) = 1 -exp (-θ), and E(I) = α+ log2 + log (0.5 +I). In the upper panel, α = 1; in the lower panel, α =0.4.
The individual creditor’s marginal revenue is P(D ~ + d) + P’(D ’+ d)d. His objective function is maximized when this is equal to zero. When maximization is achieved at d D/n, this is also the solution to equation (20). If, however, this is achieved at d>D/n, his ceiling constraint is binding, and he chooses d = Din. In a symmetrical equilibrium, marginal revenue P(nd) + P’(nd)d is examined, which is given by m(nd).
From the definition of MR(D) it is clear that V[D, I(D)] = P(D)D reaches a maximum at MR(D)= 0.
In a symmetrical equilibrium Dl is reached when every creditor forgives (D - DL)/n, D≤ DL When n - 1 creditors forgive their share, the remaining face value of debt is Dl + (D — DL)/n, and its price in the secondary market is V0/[DL + (D - DL)/n]. if the remaming creditor does not forgive, the market value of his claims is
When n -1 creditors do not provide debt relief, the nth creditor’s debt is worth V0/n if he does not provide relief, and it is worth