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Sovereign default and liquidity : The case for a world safe asset

Author

Listed:
  • François Le Grand

    (EM - EMLyon Business School)

  • Xavier Ragot

    (Sciences Po - Sciences Po, OFCE - Observatoire français des conjonctures économiques (Sciences Po) - Sciences Po - Sciences Po)

Abstract

This paper presents a positive and normative study of a world financial market when sovereign countries can default on their debt. We construct a tractable model that enables us to study sovereign default in general equilibrium. The amount of safe assets is thus endogenous and determined by international risk-sharing. We characterize the equilibrium structure and we show that the market equilibrium can generate multiple equilibria. In addition, the market equilibrium is not constrained-efficient because countries do not fully internalize the value of their debt being used as liquidity. We prove that a world fund issuing a safe asset increases aggregate welfare. The fund's relationship with the IMF's Special Drawing Rights is discussed.

Suggested Citation

  • François Le Grand & Xavier Ragot, 2021. "Sovereign default and liquidity : The case for a world safe asset," SciencePo Working papers Main hal-03188242, HAL.
    • Handle: RePEc:hal:spmain:hal-03188242
    DOI: 10.1016/j.jinteco.2021.103462
    as

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