Sovereign debt with adverse selection

We construct a dynamic equilibrium model to quantitatively study sovereign debt contingent services and country risk spreads. The sovereign's present benefits of defaulting are tempered by higher borrowing interest rates in the future. Our results suggest that the (additional) output drop due to default is an important factor in determining the qualitative nature of equilibria. The autoaggressive specification of technology shocks in conjunction with the adverse selection problem give rise to the phenomenon of "muddling through," the delay of some countries to default as way to reduce loss of reputation.