Three Essays on Sovereign Default, Self-Control and Policy Implications
Keywords: borrowing limit
Consumption Tax
Emerging Market
Self-Control Preferences
Sovereign Debt Default
Temptation

This thesis investigates the role of self-control problems in various macroeconomic environments. I adapt the Gul and Persendorfer preferences to model self-control. The first two chapters focus on sovereign defaults in emerging market economies. The third chapter studies personal finance in a credit constrained asset market. Conventional sovereign default models cannot explain some main features of the Argentine economy. They include a large sovereign debt-to-GDP ratio (31%) and a large, volatile interest rate spread (10% on average). In these conventional models, low exogenous output is the only driving force of default. These models cannot generate enough defaults without sacrificing the way data matches with those main features. The cost of default is also set too low compared to the observed data. The statistical match is especially poor during economic booms. In Chapter 1, I introduce self-control preferences into the standard setup. The sovereign faces a temptation to consume the entire wealth and save nothing for the future due to a lack of self-control. As a result, the sovereign has an incentive to incur a higher level of debt than normal. If the sovereign decides not to default, it would choose a larger repayment to reduce the temptation cost. But the larger repayment comes at the cost of a higher probability of default. As compensation, the international loan market charges a higher interest rate. This self-control model matches the data much better than the conventional models. Observational equivalence between the lack of self-control model and the low discount factor model is a concern. To answer this question, I show that the latter cannot generate the observed interest rate spreads. Introducing self-control preferences also adds computational difficulties. I develop a new computational algorithm to handle non-local approximations of the value functions. This algorithm is much more precise, and at the same time more efficient than the standard algorithms. In Chapter 2, I investigate the welfare effects of raising consumption tax on sovereign default. In a conventional sovereign default model, a consumption tax with a lump-sum rebate is neutral. In contrast, if the sovereign lacks self-control, a consumption tax can improve welfare. Calibrating the model by using Argentina's data, welfare is hump-shaped over consumption tax. The optimal tax rate is 41%, and if Argentina changes to this tax rate, the default probability reduces from 10% to 5.32%. Chapter 3 concerns the effects of raising borrowing limit in a credit-constrained setting. A rational agent cannot be worse off with an increased borrowing limit. In this case, there is no ground for imposing a credit limit to the agent. But if the decision maker lacks self-control, the reverse conclusion is true. I study two cases. In the first case, the decision maker has a non-binding credit constraint. Welfare decreases as the credit constraint relaxes, which leads to a larger temptation cost. In the second case, the decision maker has a binding credit constraint. In this case, relaxing the binding credit constraint creates a positive effect. It also offsets the increase in temptation cost. The net effect can only be positive at the margins if the decision maker's discount factor is low relative to the market.