A model of sovereign debt is analyzed. In this model, renegotiation arises in a natural way. Because information is incomplete, the renegotiation game has many equilibria. The standard contract theory approach suggests that the parties should agree to choose the efficient equilibrium strategies when the contract is written. Refinements of the equilibrium notion, such as strategic stability, suggest that a very inefficient equilibrium may be chosen. The tension between these two approaches raises deep questions about the correct way to analyze a large class of contracting problems.
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Gale et al. (1989) studied this question.
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