Building a Sovereign Benchmark The Limits of Private Coordination

Abstract

Public debt supplies liquidity and collateral services only if institutions coordinate on using the same claim. We study this coordination when use carries a recurring cost and a benefit that rises with other users. Above a quality threshold, two positive-adoption equilibria exist, and under best responses the initial user base decides between collapse and high adoption. Under logit choice, as the population grows and noise vanishes, the long-run distribution selects high adoption only above a strictly higher threshold. Debt issuance improves market depth but eventually dilutes backing per claim. This trade-off creates a range of debt levels supporting the liquidity premium of public debt in macroeconomic models and a narrower range supporting its long-run selection. At the boundary of the wider range, the premium is discontinuous. A matching transfer that corrects the adoption externality makes stationary selection maximize network surplus. Transfers can also help launch a network without permanent support.