Essays on sovereign debt and war finance

This dissertation is a collection of three independent but interrelated essays on the theory of sovereign debt and war finance. The first essay analyzes the importance of state-contingent debt-servicing in the theory of sovereign debt. The analysis shows that in a model in which a sovereign state issues for the sole purpose of smoothing expected consumption, the equilibrium amount of debt is uniquely zero, contrary to claims in the literature. An equilibrium with positive debt, however, is possible in a model of sovereign debt as contingent claim, in which debt-servicing is allowed to be state-contingent. The second essay analyzes the financial and war-spending policies of a state that faces a conflict in which defeat would result in the loss of sovereign power and in which the material consequences, conditional on avoiding defeat, are stochastic. The state uses war debt to smooth expected consumption intertemporally in response to temporary war spending, and the state also uses contingent debt-servicing to shift to lenders the risk associated with the material consequences of the war. An important innovation in the analysis is to treat the equlibrium amount of war spending, the state's resulting probability of avoiding defeat, and the equilibrium amount of borrowing as a set of endogenous variables. The third essay asks why the Confederacy undertook little external borrowing. The analysis aims to determine whether the answer is to be found in the moral hazard associated with war debt--specifically, in the failure of the state as a borrower to take into account the effect that its war spending decisions have on the risk of debt repudiation facing its lenders. The analysis finds that the Confederacy actually undertook little external borrowing because it had large mobilizable resources and that the moral hazard associated with war debt had little effect on its policies. But, the results also suggest that unimportance of the moral hazard problem is not a generic property of war finance.