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The sovereign default puzzle: Modelling issues and lessons for Europe

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  • Daniel Cohen

    (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales (EHESS) - École des Ponts ParisTech (ENPC) - École normale supérieure [ENS] - Paris - Institut national de la recherche agronomique (INRA), EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)

  • Sébastien Villemot

    (PSE - Paris-Jourdan Sciences Economiques - CNRS : UMR8545 - École des Hautes Études en Sciences Sociales (EHESS) - École des Ponts ParisTech (ENPC) - École normale supérieure [ENS] - Paris - Institut national de la recherche agronomique (INRA), EEP-PSE - Ecole d'Économie de Paris - Paris School of Economics - Ecole d'Économie de Paris)

Abstract

Why do countries default? this seemingly simple question has yet to be adequately answered in the literature. Indeed, prevailing modelling strategies compel the to choose between two enappealing model features: depending on the cost of default selected by the modeler, either the debt ratios are too high and the probability of default is toot low or the opposite is true. In view of the historical evidence that countries always default is too low or crisis, we propose a novel approach to the theory of debt default and develop a model that matches the key stylized facts regarding sovereign risk.

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Paper provided by HAL in its series PSE Working Papers with number halshs-00692038.

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Date of creation: Apr 2012
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Handle: RePEc:hal:psewpa:halshs-00692038

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Keywords: Sovereign debt ; Lévy stochastic processes;

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