But like car insurers, investors in capital markets worry about perverse incentives. Not so much about imprudent driving, but about some other forms of imprudence. A borrower’s income is not only subject to exogenous shocks. It is also the outcome of his decisions.
Investors therefore worry that providing full insurance against the risk of 3 income fluctuations can lead to irresponsible – for example, short-term-oriented – investment or policy decisions. When financing sovereigns, an additional and somewhat more fundamental problem arises: the so-called willingness to pay. Governments cannot be forced or be contractually obliged to repay their debt.