In a dynamic model of a small economy, we study sovereign default and debt

renegotiation.
The country maximizes expected utility given by:

Its endowment,

is stochastic and has distribution

The country on borrow from or lend to international investors via one-period zerocoupon bonds at face value b, and pay 1 unit next period. If the country borrows,
b<0, if it lends, b>0. Set

, where

, which is the largest debt level that the

country could repay. Let q(b,y) be the price of a bond with face value b the country
with an endowment stock y.
International investors are risk-neutral and have perfect information are the
countrys endowment and asset position. They can borrow or lend