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Sovereign Debt, Volatility and Insurance

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  • Kenneth Kletzer

Abstract

External debt increases the vulnerability of indebted emerging market economies to macroeconomic volatility and financial crises. Capital account reversals often lead to sovereign debt repayment crises that are only resolved after prolonged and difficult debt restructuring. Foreign indebtedness exacerbates domestic financial distress in crisis, increasing both the incidence and severity of emerging market crises. These outcomes contrast with the presumption that access to international capital markets should help countries to smooth domestic consumption and investment against macroeconomic shocks. This paper uses models of sovereign to reconsider the role of sovereign debt renegotiation for international risk sharing and presents an approach for analyzing contractual innovations for implementing contingent debt repayments. The financial innovations that might allow risk-sharing rather than risk-inducing capital flows go beyond contractual changes that ease debt renegotiation by separating contingent payments from bonds.

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Paper provided by Central Bank of Chile in its series Working Papers Central Bank of Chile with number 330.

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Date of creation: Sep 2005
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Handle: RePEc:chb:bcchwp:330

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  1. Herschel I. Grossman & John B. Van Huyck, 1989. "Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation," NBER Working Papers 1673, National Bureau of Economic Research, Inc.
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  13. Jeremy A.Rogoff Bulow & Kenneth, 1986. "A Constant Recontracting Model of Sovereign Debt," University of Chicago - George G. Stigler Center for Study of Economy and State 43, Chicago - Center for Study of Economy and State.
  14. Worrall, Tim, 1990. "Debt with potential repudiation," European Economic Review, Elsevier, vol. 34(5), pages 1099-1109, July.
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  17. Robert Townsend, 1979. "Optimal contracts and competitive markets with costly state verification," Staff Report 45, Federal Reserve Bank of Minneapolis.
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