What does sovereign borrowing signal?

Abstract

We assess the relative importance of three common sources of government private information in asymmetric-information models of sovereign debt: time preference, default costs, and future economic fundamentals. We develop a parsimonious signaling model that nests all three information structures and show that only private information about future fundamentals can generate a state-dependent signaling effect of sovereign borrowing on default risk. More borrowing signals stronger fundamentals when public repayment conditions are favorable, but weaker fundamentals when they are unfavorable.