This paper examines the optimal debt contract between lenders and a sovereign borrower when the borrower is free to repudiate the debt and when his decision to invest or consume borrowed funds is unobservable. We show that recurrent debt crises are a necessary part of the incentive structure which supports the optimal pattern of lending.
Published in _Econometrica_
(vol. 59, no. 4, July 1991, pp. 1069-1089) https://doi.org/10.2307/2938174.