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Optimal costs of sovereign default

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  • Leonardo Pio Perez

Abstract

I 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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File URL: http://www.bcb.gov.br/pec/wps/ingl/wps236.pdf
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Bibliographic Info

Paper provided by Central Bank of Brazil, Research Department in its series Working Papers Series with number 236.

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Date of creation: Apr 2011
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Handle: RePEc:bcb:wpaper:236

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Web page: http://www.bcb.gov.br/?english

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Cited by:
  1. José Renato Haas Ornelas & José Santiago Fajardo Barbachan & Aquiles Rocha de Farias, 2012. "Estimating Relative Risk Aversion, Risk-Neutral and Real-World Densities using Brazilian Real Currency Options," Working Papers Series 269, Central Bank of Brazil, Research Department.
  2. Benjamin M. Tabak & Marcelo Yoshio Takami & J. M. C. Rocha & Daniel O. Cajueiro, 2011. "Directed Clustering Coefficient as a Measure of Systemic Risk in Complex Banking Networks," Working Papers Series 249, Central Bank of Brazil, Research Department.

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