UiS Working Papers in Economics and Finance,
University of Stavanger

Abstract: A game theoretic model of six kinds of players, i.e. countries, central banks, banks, firms, households, and financial inter-governmental organizations. Each player has a strategy set, with strategies such as setting interest rates, lending, borrowing, producing, consuming, investing, importing, exporting, defaulting, and penalizing default. Markets for goods, debt, and capital are modeled endogenously. This rich conceptualization of strategic opportunities for as many as six types of players is richer than anything that has been attempted earlier. The 2005-2011 empirical data for Greece is used to analyze how utility is impacted by public consumption and lump sum transfers, assuming negative productivity shocks, analyzing several time periods, with and without the possibility of default. The 2007-2008 empirical data for Greece and Germany is used to determine how the two countries’ utilities depend on Greece’s public 2007 consumption, with and without negative productivity shocks. Greece’s2 high debt burden is shown to make default optimal with high shock magnitude is low default penalty. Germany has limited ability, through its available strategies, to prevent the default, and may resort to unconventional tools such as debt forgiveness and changing the default penalty.

Keywords: Game theory; sensitivity analysis; economic risk; default; contagion

JEL-codes: C60; C70; G01

62 pages, November 10, 2015

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