EQUILIBRIUM CHARACTERISTICS OF SOVEREIGN DEFAULT IN A TWO COUNTRY CURRENCY AREA: A TWO PLAYER DYNAMIC HIERARCHICAL GAME

摘要

This paper is aimed at developing a two player dynamic hierarchical game called the Sovereign Default Game in order to study the optimality of default in a two country currency area where the larger economy is the leader and the smaller economy acts as the follower. Our approach is a monetary general equilibrium model where the leader sets the monetary policy in the currency area but the follower experiences a real exchange rate over-valuation that may lead to default. We find two maxima of maxima, one of them "perverse" in the sense that it generates moral hazard.