Optimal costs of sovereign default
AbstractI apply a standard model of sovereign debt in order to identify the optimal costs of default from the ex-ante point of view of the borrower. I depart from the literature by distinguishing events of strong economic crises from standard business cycles. Crisis events seem to be appropriate moments in which the option to default might be welfare improving by providing state contingency in the debt contract. The quantitative analysis shows that the costs of default should be limited, leaving default as an option, but at much higher levels than the ones consistent with the observed debt-output and default ratios of emerging economies. The results in this paper have implication on the evolution of sovereign debt workout procedures and the potential demand for new debt instruments.
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Bibliographic InfoPaper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 236.
Date of creation: Apr 2011
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2011-04-23 (All new papers)
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