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Uncertainty Premia, Sovereign Default Risk, and State-Contingent Debt

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  • Francisco Roch
  • Francisco Roldán

Abstract

We study the pricing, design, and desirability of sovereign state-contingent debt instruments. Using a sovereign default model with lenders who fear model misspecification, we find that the commonly used threshold bond structure leads to welfare losses for the government. While this bond would be beneficial when facing rational expectations lenders, its threshold structure increases the variance of promised returns, which robust lenders dislike. Sovereign state-contingent debt instruments can still be welfare improving when facing robust lenders when designed optimally. Our findings tie the lack of popularity of sovereign state-contingent debt instruments to the particular design used thus far.

Suggested Citation

  • Francisco Roch & Francisco Roldán, 2023. "Uncertainty Premia, Sovereign Default Risk, and State-Contingent Debt," Journal of Political Economy Macroeconomics, University of Chicago Press, vol. 1(2), pages 334-370.
    • Handle: RePEc:ucp:jpemac:doi:10.1086/723950
    DOI: 10.1086/723950
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    Cited by:

    1. Dvorkin, Maximiliano & Sánchez, Juan M. & Sapriza, Horacio & Yurdagul, Emircan, 2022. "Improving sovereign debt restructurings," Journal of Economic Dynamics and Control, Elsevier, vol. 139(C).
    2. Sosa-Padilla, César & Sturzenegger, Federico, 2023. "Does it matter how central banks accumulate reserves? Evidence from sovereign spreads," Journal of International Economics, Elsevier, vol. 140(C).
    3. Daniel C. L. Hardy, 2022. "Alternatives in the Design of Sovereign Green Bonds," wiiw Policy Notes 62, The Vienna Institute for International Economic Studies, wiiw.

    More about this item

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • O16 - Economic Development, Innovation, Technological Change, and Growth - - Economic Development - - - Financial Markets; Saving and Capital Investment; Corporate Finance and Governance

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