Commitment in the Canonical Sovereign Default Model

We study the role of lack commitment in shaping the allocations of the canonical incomplete-markets sovereign default model of Eaton and Gersovitz (1981). We show how the equilibriumwith commitment to the circumstances under which default can be undertaken involves a verydifferent set of functional equations than in the equilibrium without commitment. It turns outthat, in practice, under commitment default does not exist in all but very extreme quantitativeenvironments. We document how the standard specification of Arellano (2008) displays no default ifthere is commitment, even in the absence of both utility cost and exclusion from borrowing. Whileless standard specifications can produce some default under commitment, we provide examples thatdemonstrate how rare default is. We interpret default as a recourse of last resort