default risk and risk averse international investors abstract this paper develops an endogenous default risk model for small open economies that interact with risk averse international investors whose preferences exhibit decreasing absolute risk aversion dara by incorporating risk averse investors who trade with an emerging economy the present model explains a larger proportion and volatility of the spread between sovereign bonds and riskless assets than the standard model with risk neutral investors the paper shows that if investors have dara preferences then the emerging economy s default risk capital flows and bond prices are a function not only of the fundamentals of the economy but also of the level of financial wealth and risk aversion of international investors in particular as investors become wealthier or less risk averse the emerging economy becomes less credit constrained as a result the emerging economy s default risk is lower and its bond prices and capital inflows are higher additionally with risk averse investors the risk premium in the asset prices of the sovereign countries can be decomposed into two components a base premium that compensates the investors for the probability of default and an excess premium that compensates them for taking the risk of default

the sources of sovereign risk a calibration based on levy stochastic processes abstract governments choose to issue risky or riskless debt depending on the nature of the stochastic process of output we use brownian motion and poisson shocks a modeling method in the literature on corporate default known as levy processes to approximate a decomposition of the output process into a smooth and a jump component using an eaton and gersovitz 1981 model of debt repudiation we show that the brownian part explains the counter cyclical behavior of the current account and the poisson part explains the risk of default thus enabling our model to account for key stylized facts regarding sovereign risk

a quantitative model of sovereign debt bailouts and conditionality in times of sovereign debt crises international financial institutions provide temporary financial support contingent on the implementation of specific macroeconomic policies this paper develops a model of sovereign debt and default with endogenous participation rates in bailout programs conditionality enters as a constraint on fiscal policy in the model the insurance character of bailouts generates incentives for debt accumulation quantitative results suggest that bailouts prevent sovereign defaults in the short run but may come at a cost of a greater default probability in the long run increasing the intensity of conditionality lowers the bailout participation rate and generates a hump shaped pattern of sovereign default risk

sovereign debt as a contingent claim a quantitative approach abstract we construct a dynamic equilibrium model with contingent service and adverse selection to quantitatively study sovereign debt in the model benefits of defaulting are tempered by higher future interest rates for a wide set of parameters the only equilibrium is one in which the sovereign defaults in all states additional output losses however sustain equilibria that resemble the data we show that due to the adverse selection problem some countries choose to delay default to reduce loss of reputation moreover although equilibria with no default imply greater welfare levels they are not sustainable in highly indebted and volatile countries

the dynamics of sovereign default risk and political turnover abstract this paper develops a stochastic dynamic politico economic model of sovereign debt to analyze the interaction of sovereign default risk and political turnover two parties differ in their preferred size of unproductive public spending which is financed by taxes and external debt electoral outcomes are characterized by the economic benefits from the incumbent s policies and stochastic idiosyncratic ideological aspects quantitative findings suggest that endogenous political turnover increases the discrepancies between the optimal borrowing and default policies of the two parties prior to a debt crisis the incumbent government accumulates external debt to foster the probability of remaining in power the dynamic interaction of electoral outcomes external debt and sovereign default supports arguments for imposing institutional constraints on incumbent governments

external debt capital flight and political risk abstract this paper explains the simultaneous occurence of large external debts private capital outflows and low domestic capital formation we consider a general equilibrium model in which two government types with conflicting distributional goals randomly alternate in office uncertainty over the fiscal policies of future governments generates capital flight and small domestic investment and induces the government to overaccumulate external debt the model also predicts that left wing governments are more inclined to restrict capital outflows than right wing governments finally we examine how political uncertainty affects the risk premium and how debt repudiation may occur after a regime change

sovereign debt sustainability in advanced economies we develop a measure of maximum sustainable government debt for advanced economies how much investors are willing to lend to a country s government depends on the country s expected primary surplus the level and volatility of its rate of growth and how much debt the government expects to be able to raise in the future for the purpose of servicing the debt it seeks to raise today we provide a simple formula that computes a country s maximum sustainable debt msd as a function of four easy to estimate parameters we further compute a country s theoretical probability of default pd as a function of its debt to gdp ratio we nally calibrate our measures for 23 oecd countries and test the relation between sovereign yield spreads and our theoretical pd at prevailing debt levels we nd it to be strongly statistically signicant jel h63

sovereign and private default risks over the business cycle abstract sovereign debt crises are often accompanied by deep recessions with sharp declines in external credit to the private sector in a sample of emerging economies we find that both sovereign and private interest rate spreads are countercyclical this paper presents a model of a small open economy that accounts for these empirical regularities it includes private firms which finance a fraction of imports by external debt and are subject to idiosyncratic productivity risk and a government which borrows internationally and taxes firms to finance public expenditures the model gives rise to endogenous private and sovereign interest rate spreads and a dynamic feedback mechanism between sovereign and private default risks through the endogenous response of fiscal policy to adverse productivity shocks

recent developments in quantitative models of sovereign default the current crisis and discussions in the euro area in particular show that sovereign debt crises defaults are no longer confined to developing economies following crises in many latin american countries the literature on quantitative dynamic macro models of sovereign default has been advancing rapidly current debate should take note of the findings of this literature an extensive overview of which has been provided in this paper this paper also discusses the inherent difficulties as well as possibilities of integrating this type of model into standard business cycle models rbc and dsge models this is likely to be particularly helpful when using models to analyse upcoming issues in the euro area such as a suitable sovereign insolvency law or the assumption of joint liability

debt dilution and sovereign default risk we measure the effects of debt dilution on sovereign default risk and study debt covenants that could mitigate these effects we calibrate a baseline model with endogenous debt duration and default risk in which debt can be diluted using data from spain we find that debt dilution accounts for 78 percent of the default risk in the baseline economy and that eliminating dilution increases the optimal duration of sovereign debt by almost 2 years eliminating dilution also increases consumption volatility but still produces welfare gains the debt covenants we study could help enforcing fiscal rules

politics and perceived country creditworthiness in international banking this paper marks a departure from most previous studies of country creditworthiness in international banking because it incorporates systematically generated quantitative indicators of political instability in the analysis the authors empirically test for the effects of political instability on perceived country creditworthiness using data on thirty heavily indebted developing countries for the period 1967 86 in addition to economic factors they examine the effects of three types of political instability regime change political legitimacy and armed conflict the authors also distinguish between proximate instability and chronic instability they find significant effects of proximate instability particularly in governmental regime on indicators of countries perceived creditworthiness copyright 1990 by ohio state university press

repatriation of debt in the euro crisis with the beginning of the euro crisis the long standing trend of european financial integration reversed investors unwound cross border positions of debt obligations and increased holdings of locally issued debt in other words debt obligations were repatriated we use data on bank portfolios to document three new empirical regularities of the financial disintegration i repatriation affected mainly debt of crisis countries ii repatriation affected mainly public debt iii the public debt of crisis countries that was not repatriated was reallocated to large and politically influential countries within the euro area we read these results in light of standard theories of cross border portfolio allocation and argue that the sum of these patterns constitutes evidence for the secondary market theory of public debt

sovereign debt optimal contract underinvestment and forgiveness in this paper we develop a time consistent rational expectations model which analyzes the equilibrium loan contract between a borrowing country and a foreign bank the loan contract specifies both the amount of the loan and the promised interest payments and rationally reflects the investment decisions of the country and the possibilities of renegotiation and repudiation of the debt an important feature of the model is that at the initial negotiation of the loan there is uncertainty about whether the country will renegotiate for partial forgiveness in the future and whether it will eventually repudiate the debt even having successfully renegotiated moreover the probabilities of renegotiation and repudiation and the amount of possible forgiveness are endogenously determined in the model the repudiation decision is directly related to the underinvestment problem the objective of the renegotiation is precisely to alleviate this problem the model is used to analyze the effects of four variables on both the optimal contract and the country s welfare the degree of penalties that a bank can impose on a defaulting country the uncertainty of production the productivity of investments and the riskless interest rate the analysis has policy implications as well as testable predictions during the last ten years the issues related to less developed countries ldcs debt have become increasingly more important in the world economy the main reason for this is the significant increase in the amount of debt outstanding and the consequent higher yearly interest payments by 1988 seventeen highly indebted countries had an aggregated debt of 510 billion dollars see rogoff 1990 a second important reason is that starting in 1982 some of these countries suspended debt service payments creating a serious crisis of confidence in the banking system of the lending countries as a consequence borrowers and lenders have had to engage in negotiations including the rescheduling of the repayments and possibly partial forgiveness a number of papers have suggested that forgiveness could conceivably make both lenders and borrowers better off because the country

the effects of the value added tax on revenue and inequality this paper examines the impact of the introduction of the value added tax on inequality and government revenues using newly released macro data we present both conventional country fixed effect re

the political economy of sovereign defaults abstract how do income distribution and the tax system affect sovereign borrowing and default decisions are these effects shaped by the political constraints that governments face when raising revenues to repay the debt to address these questions we incorporate agent heterogeneity in terms of income distribution and tax burden and a political support constraint into a standard dsge model of sovereign default the results show that income inequality and regressive taxes make defaults more likely for a given level of debt while they reduce sovereign borrowing in equilibrium tighter political support requirements reinforce these effects

why a stubborn conservative would run a deficit policy with time inconsistent preferences a conservative government in favor of a low level of public consumption knows that it will be replaced by a government in favor of a larger level of public consumption we show that the resulting level of public consumption is in between the levels the two governments would choose if each were in power both in the present and in the future in particular we show that if the conservative government is more stubborn in a particular sense than the succeeding government the conservative government will borrow more than it would had it remained in power in the future

growth in the shadow of expropriation we propose a tractable variant of the open economy neoclassical growth model that emphasizes political economy and contracting frictions the political economy frictions involve a preference for immediate spending while the contracting friction is a lack of commitment regarding foreign debt and expropriation we show that the political economy frictions slow an economy s convergence to the steady state due to the endogenous evolution of capital taxation the model rationalizes why openness has different implications for growth depending on the political environment why institutions such as the treatment of capital income evolve over time why governments in countries that grow rapidly accumulate net foreign assets rather than liabilities and why foreign aid may not affect growth

decentralized borrowing and centralized default abstract in the past foreign borrowing by developing countries was comprised almost entirely of government borrowing however private firms and individuals in developing countries now borrow substantially from foreign lenders it is often asserted that this surge in private sector borrowing generates excessive borrowing and frequent sovereign defaults in developing countries this paper analyzes the impact of decentralized borrowing using a quantitative model in which private agents decide how much to borrow and the government decides whether to default relative to a model in which the government determines both the level of borrowing and whether to default decentralized borrowing drives up aggregate credit costs and sovereign default risk and reduces aggregate welfare interestingly decentralized borrowing may lead to either too much or too little debt in equilibrium depending on the severity of default penalties

welfare analysis of currency regimes with defaultable debts abstract we modify the cole and kehoe model by including domestic debt according to the original model a speculative attack on a high debt level issued abroad triggers external debt default here it is possible to inflate away the domestic debt to avoid the external debt default we consider two possibilities for domestic debt denomination i local currency and ii common currency in the second case inflation depends on a monetary union decision our numerical results show that to have a debt share denominated in a common currency is optimal when the refinancing risks are highly correlated across union members otherwise the best is to keep the domestic debt denominated in local currency finally the extreme case of having all debt issued abroad and denominated in a foreign currency is suitable when under alternative regimes suboptimal inflation motivated by political factors is likely although the paper was originally developed for emerging market economies it sheds some light on the recent eurozone crisis

asset backed contracts and sovereign risk abstract a fundamental problem with sovereign default is the lack of a legal enforcement mechanism since the 1920s there have been an ongoing set of initiatives undertaken by the league of nations and the unctad to set international laws on borrowing and lending standards all of which have failed to address the unenforceability problem this paper proposes to use asset backed contracts where the usufruct of the asset transfers to the asset holder unlike conventional sovereign borrowing there are international laws governing asset backed contracts which allow the international assets of a country to be seized this paper exemplifies on the idea that asset backed contracts which are also widely practiced in islamic finance can provide a solution to unenforceable sovereign debt contracts the paper focuses specifically on argentina which has defaulted twice in 13 years if argentina had utilized asset backed contracts prior to its 2001 debt default it would have gained from the following advantages higher debt to gdp ratios larger welfare gains lower probability of default and thus lower borrowing costs

statistical properties of country risk ratings under oil price volatility evidence from selected oil exporting countries abstract this paper focuses on the application of panel models for identification and analysis of influence of oil price volatility on statistical properties of country risk ratings which stem from uncertainty of macroeconomic fluctuations firstly two statistical properties of country risk ratings volatility clustering and asymmetrical revision were identified in a theoretical framework based on cruces 2006 secondly considering the oil price volatility numerical experiments were conducted based on extended models to test and verify specific properties of country risk ratings in selected oil exporting countries empirical results suggest that properties of country risk remain comparatively steady despite oil price volatility it is also found that the oil price volatility can obviously exaggerate the country risk volatility as it happened during 2007 2009 country clustering based on the properties of country risk ratings shows that the selected countries maintain a significant clustering tendency these features are of great importance for estimating risk exposure of international trade and investments in oil export during extreme situations

debt arrears in latin america do political variables matter political instability and debt problems characterise latin america in the last two decades this article estimated a logit model of debt arrears including economic as well as political variables our results suggested that both economic and political indicators affected debt repayment in latin america during 1971 86 we also cast a shadow on the viewpoint that authoritarian and military regimes have an advantage over democratically elected governments with regard to debt related issues

consumption savings decisions with quasi geometric discounting we study the consumption savings problem of an infinitely lived rational consumer who has time inconsistent preferences in the form of quasi geometric discounting the consumer operates a weakly concave production function and must simply divide current resources into current consumption and savings there is no uncertainty a solution to the consumer s problem is a subgame perfect equilibrium of a dynamic game between the consumer s successive selves we show that this game has a continuum of equilibria in stationary markov strategies not only is the stationary point of the consumer s asset holdings indeterminate but each stationary point has a continuum of dynamic paths converging to it the savings policy rules underlying these dynamic paths are step functions

decreasing serial cost sharing under economies of scale we consider the problem of cost sharing in the presence of increasing returns to scale and potential strategic behavior on the part of consumers we show that any smooth and strictly monotonic mechanism for which a nash equilibrium exists for all profiles of convex and monotonic preferences must be dictatorial however we propose a cost sharing mechanism the decreasing serial mechanism for which an interesting domain restriction ensures existence of a noncooperative equilibrium for its cost sharing game a characterization theorem of the mechanism based on the strategic properties of existence uniqueness and efficiency of its noncooperative equilibrium is provided journal of economic literature classification numbers c70 c72 d70 cost allocation is a practical problem that organizations of all kinds face universities allocate computing costs among departments aviation authorities set landing fees for aircraft based on their size regulatory com missions set rates for electricity water and other utilities based on the costs of providing these services the common feature in all of these exam ples is that prices are not determined externally by market forces but are set internally by mutual agreement or administrative decision a simple situation where a cost sharing problem can emerge is when a set of users share a technology that transforms a single input into a single output we study this cost sharing problem when the cost function is increasing and concave examples include the division of costs incurred in setting telephone lines or a water supply system the assessment of fees to pay for a secretary or a gardener s services and so on the situations we have in mind are those of cooperative production or natural nonregulated monopolies for either of these situations there is no obvious answer to the question of how to divide the cost of producing the total output among the users

time varying volatility default and the sovereign risk premium this paper studies how changes in the volatility of aggregate income aect the sovereign spread i document a positive correlation between sovereign spreads and aggregate income volatility for a set of european economies then i propose a model with endogenous sovereign spread and time varying volatility to understand this fact i nd that volatility changes aect savings and the sovereign spread however the impact of volatility shocks is state dependent when the economy is relatively rich an increase in volatility generates precautionary savings instead when the economy is relatively poor an increase in volatility induces an increase in foreign debt and a higher spread this mechanism is absent in standard business cycle models and only appears because of the default option moreover this mechanism can generate a substantial variability of spreads only due to volatility shocks in this way the model is able to rationalize the positive correlation between sovereign spreads and volatility observed in the data

the dynamics of government abstract we model income redistribution with dynamic distortions as determined by rational voting without commitment among individuals of different types and income realizations we find that redistribution is too persistent relative to that chosen by a planner with commitment the difference is larger the lower is the political influence of young agents the lower is the altruistic concern for future generations and the lower is risk aversion furthermore there tends to be too much redistribution in the political equilibrium finally smooth preference aggregation as under probabilistic voting produces less persistence and does not admit multiple equilibria which occur under majority voting aggregation

heterogeneous borrowers in quantitative models of sovereign default we extend the model used in recent quantitative studies of sovereign default allowing policymakers of different types to stochastically alternate in power we show that a default episode may be triggered by a change in the type of policymaker in office and that such a default is likely to occur only if there is enough political stability and if policymakers encounter poor economic conditions under high political stability political turnover enables the model to generate a weaker correlation between economic conditions and default decisions a higher and more volatile spread and lower borrowing levels after a default episode

long duration bonds and sovereign defaults abstract this paper extends the baseline framework used in recent quantitative studies of sovereign default by assuming that the government can borrow using long duration bonds this contrasts with previous studies which assume the government can borrow using bonds that mature after one quarter we show that when we assume that the government issues bonds with a duration similar to the average duration of sovereign bonds in emerging economies the model generates an interest rate that is substantially higher and more volatile than the one obtained assuming one quarter bonds this narrows the gap between the predictions of the model and the data which indicates that the introduction of long duration bonds may be a useful tool for future research about emerging economies our analysis is also relevant for the study of other credit markets

income inequality and sovereign default abstract in this paper we study how income inequality matters for government borrowing and default decisions we extend a standard endogenous sovereign debt default model to allow for heterogeneous agents and stochastic variability in the dispersion of income we calibrate the model to match a number of stylized facts for argentina we show that i rising income inequality within a country increases the probability of default significantly ii the effect of output shocks is larger than the effect of inequality shocks iii the joint effect of these two shocks can generate a high default probability consistent with the argentine data iv the model can match the high volatility of consumption by the poor relative to the rich and v more progressive income taxes lead to lower default risk

sovereign default interest rates and political uncertainty in emerging markets abstract a large body of the empirical literature shows that high turnover rates length of tenure of policymakers and the degree of conflict within a country affects sovereign spreads debt and default rates we help to rationalize such claims by including these political features in a dynamic stochastic small open economy model of sovereign debt and default in this way we offer a complementary approach to the econometric analyses in the literature consistent with the data the quantitative analysis shows that politically unstable and more polarized economies experience higher default rates and larger level and volatility of sovereign interest rate spreads

why are there serial defaulters evidence from constitutions abstract presidential democracies were 4 9 times more likely than parliamentary democracies to default on external debts between 1976 and 2000 in this article i argue that the explanation for the serial defaults by a number of sovereign borrowers lies in their constitutions ceteris paribus parliamentary democracies are less likely than presidential democracies to default on their liabilities because the confidence requirement creates a credible link between economic policies and the executive s political survival this link tends to strengthen the repayment commitment when politicians are opportunistic i show that this effect is large in the contemporary world even when the comparison is restricted to countries that are similar in terms of colonial origin geography and economic variables since a country s form of government is typically chosen at the time of independence and is highly persistent over time constitutions can explain why debt policies in developing countries are related to individual

spending biased legislators discipline through disagreement this paper studies politicians who have a present bias for spending they want to increase current spending and procrastinate spending cuts we argue that legislators bias is more severe in economies with low institutional quality we show that disagreement in legislatures leads to policy persistence and that this attenuates the temptation to overspend depending on the environment legislators decisions to be fiscally responsible may either complement or substitute other legislator s decisions in economies with weak institutions politicians actions are strategic complements thus institutional changes that induce fiscal responsibility are desirable they generate a positive responsibility multiplier and reduce inefficient spending however in economies with better institutions the same institutional change would induce some legislators to free ride on others responsibility and may lead to more inefficient spending