Sovereign Debt and Joint Liability: An Economic Theory Model for Amending the Treaty of Lisbon

As the euro area crisis drags on, it is evident that a part of the problem lies in the architecture of debt within the euro area. This study argues that at least part of the debt problem could be addressed through limited cooperative action entailing appropriately structured contracts generating cross‐country liability for sovereign debt incurred by individual nations within the European Union. Such agreements are currently proscribed by the Treaty of Lisbon. We construct a game‐theoretic model demonstrating that there exist self‐fulfilling equilibria, which are Pareto superior to the existing outcome and which would come into existence if cross‐country debt liabilities were permitted.