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Optimal External Debt and Default

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  • Bernardo Guimaraes

Abstract

This paper analyses whether sovereign default episodes can be seen as contingencies of optimal international lending contracts. The model considers a small open economy with capital accumulation and without commitment to repay debt. Taking first order approximations of Bellman equations, I derive analytical expressions for the equilibrium level of debt and the optimal debt contract. In this environment, debt relief generated by reasonable fluctuations in productivity is an order of magnitude below that generated by shocks to world interest rates. Debt relief prescribed by the model following the interest rate hikes of 1980-81 accounts for a substantial part of the debt forgiveness obtained by the main Latin American countries through the Brady agreements.

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Bibliographic Info

Paper provided by Centre for Economic Performance, LSE in its series CEP Discussion Papers with number dp0847.

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Date of creation: Feb 2008
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Handle: RePEc:cep:cepdps:dp0847

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Web page: http://cep.lse.ac.uk/_new/publications/series.asp?prog=CEP

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Keywords: sovereign debt; default; capital flows; optimal contract; world interest rates;

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Cited by:
  1. Nathan Foley-Fisher & Bernardo Guimaraes, 2012. "U.S. real interest rates and default risk in emerging economies," International Finance Discussion Papers 1051, Board of Governors of the Federal Reserve System (U.S.).
  2. Boz, Emine, 2011. "Sovereign default, private sector creditors, and the IFIs," Journal of International Economics, Elsevier, vol. 83(1), pages 70-82, January.
  3. Joy, Mark, 2012. "Sovereign default and macroeconomic tipping points," Research Technical Papers 10/RT/12, Central Bank of Ireland.
  4. Ahmad Danu Prasetyo & Naoyuki Yoshino, 2013. "Improving the Government Debt Market Quality by Determining the Optimal Structure of Government Debt Portfolio," Keio/Kyoto Joint Global COE Discussion Paper Series 2012-038, Keio/Kyoto Joint Global COE Program.

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