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Persistent Gaps, Volatility Types, and Default Traps

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  • Ana Fostel
  • Sandeep Kapur
  • Luis Catão

Abstract

We show that cross-country differences in the underlying volatility and persistence of macroeconomic shocks help explain two historical regularities in sovereign borrowing: the existence of "vicious" circles of borrowing-and-default ("default traps"), as well as the fact that recalcitrant sovereigns typically face higher interest spreads on future loans rather than outright market exclusion. We do so in a simple model where output persistence is coupled with asymmetric information between borrowers and lenders about the borrower''s output process, implying that a decision to default reveals valuable information to lenders about the borrower''s future output path. Using a broad cross-country database spanning over a century, we provide econometric evidence corroborating the model''s main predictions-namely, that countries with higher output persistence and conditional volatility of transient shocks face higher spreads and thus fall into default traps more easily, whereas higher volatility of permanent output tends to dampen these effects.

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Bibliographic Info

Paper provided by International Monetary Fund in its series IMF Working Papers with number 07/148.

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Length: 45
Date of creation: 01 Jun 2007
Date of revision:
Handle: RePEc:imf:imfwpa:07/148

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Keywords: Production; Economic models; Borrowing; bond; bonds; sovereign bond; sovereign debt; bondholders; repayments; serial defaulters; long-term bonds; term bonds; bond yields; bond issuance; debt intolerance; debt renegotiation; debt servicing; international capital; international capital markets; sovereign default; bond prices; sovereign borrower; financial markets; ratio of debt; debt ratios; bond financing; debt crisis; external borrowing; risk-free ? interest rate; currency crises; risk-free interest rate; debt burden; currency crisis; debt maturity; emerging market bond; short-term debt; domestic-currency; international financial markets; derivative; current account; foreign bonds; market bond; international reserves; international bond; public debt; excessive volatility; debt service; foreign currency debt; denominated bonds; currency mismatches; bond holders; external debt; discount rate; bond issues; sovereign borrowers; international debt; international financial statistics; bond rate; debt default; financial fragility; public borrowing; international loans; debt defaults; international bond financing; bond market; bond index; discount bonds; currency debt; currency composition; present value; bond spreads; international lending; bond price; bond indices;

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References

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  1. Bordo, Michael D. & Rockoff, Hugh, 1996. "The Gold Standard as a “Good Housekeeping Seal of Approval”," The Journal of Economic History, Cambridge University Press, vol. 56(02), pages 389-428, June.
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Citations

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Cited by:
  1. Fløgstad, Cathrin N. & Nordtveit, Ingvild, 2014. "Lending to developing countries: How do official creditors respond to sovereign defaults?," Working Papers in Economics 01/14, University of Bergen, Department of Economics.
  2. Bednarik, Radek, 2008. "Analýza volatility devizových kurzů vybraných ekonomik
    [The Analysis of Volatility of Selected Countries' Exchange Rates]
    ," MPRA Paper 15046, University Library of Munich, Germany.
  3. Ana Fostel & John Geanakoplos, 2008. "Emerging Markets in an Anxious Global Economy," Cowles Foundation Discussion Papers 1646, Cowles Foundation for Research in Economics, Yale University.
  4. Ugo Panizza & Federico Sturzenegger & Jeromin Zettelmeyer, 2010. "International Government Debt," UNCTAD Discussion Papers 199, United Nations Conference on Trade and Development.

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