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Maturity, Indebtedness, and Default Risk

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  • Satyajit Chatterjee

    ()
    (Federal Reserve Bank of Philadelphia)

  • Burcu Eyigungor

Abstract

We present a novel and tractable model of long-term sovereign debt. We make two sets of contributions. First, on the substantive side, using Argentina as a test case we show that unlike one-period debt models, our model of long-term sovereign debt is capable of accounting for the average spread, the average default frequency, and the average debt-tooutput ratio of Argentina over the 1991-2001 period without any deterioration in the model’s ability to account for Argentina’s cyclical facts. Using our calibrated model we determine what Argentina’s debt, default frequency and welfare would have been if Argentina had issued only short-term debt. Second, on the methodological side, we advance the theory of sovereign debt begun in Eaton and Gersovitz (1981) by establishing the existence of an equilibrium pricing function for long-term sovereign debt and by providing a fairly complete set of characterization results regarding equilibrium default and borrowing behavior. In addition, we identify and solve a computational problem associated with pricing long-term unsecured debt that stems from nonconvexities introduced by the possibility of default.

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Bibliographic Info

Paper provided by Koc University-TUSIAD Economic Research Forum in its series Koç University-TUSIAD Economic Research Forum Working Papers with number 0901.

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Length: 44 pages
Date of creation: Feb 2009
Date of revision:
Handle: RePEc:koc:wpaper:0901

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Keywords: Unsecured Debt; Sovereign Debt; Long Duration Bonds; Debt Dilution; Random Maturity Bonds; Default Risk;

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References

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  1. Fernando Broner & Guido Lorenzoni & Sergio Schmuckler, 2006. "Why Do Emerging Economies Borrow Short Term?," 2006 Meeting Papers 841, Society for Economic Dynamics.
  2. R. Gaston Gelos, Ratna Sahay and Guido Sandleris, 2008. "Sovereign Borrowing by Developing Countries: What Determines Market Access?," Business School Working Papers 2008-02, Universidad Torcuato Di Tella.
  3. Mark Aguiar & Gita Gopinath, 2004. "Defaultable debt, interest rates, and the current account," Working Papers 04-5, Federal Reserve Bank of Boston.
  4. Athreya, Kartik B., 2002. "Welfare implications of the Bankruptcy Reform Act of 1999," Journal of Monetary Economics, Elsevier, vol. 49(8), pages 1567-1595, November.
  5. Cristina Arellano & Ananth Ramanarayanan, 2012. "Default and the Maturity Structure in Sovereign Bonds," Journal of Political Economy, University of Chicago Press, vol. 120(2), pages 187 - 232.
  6. Satyajit Chatterjee & Dean Corbae & Makoto Nakajima & José-Víctor Ríos-Rull, 2007. "A Quantitative Theory of Unsecured Consumer Credit with Risk of Default," Econometrica, Econometric Society, vol. 75(6), pages 1525-1589, November.
  7. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2010. "Online Appendix to "Quantitative properties of sovereign default models: solution methods"," Technical Appendices 08-133, Review of Economic Dynamics.
  8. Gabriel Cuadra & Horacio Sapriza, 2006. "Sovereign Default, Interest Rates and Political Uncertainty in Emerging Markets," Working Papers 2006-02, Banco de México.
  9. Juan Carlos Hatchondo & Leonardo Martinez, 2009. "Long-duration bonds and sovereign defaults," Working Paper 08-02, Federal Reserve Bank of Richmond.
  10. Cole, Harold L & Kehoe, Timothy J, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Wiley Blackwell, vol. 67(1), pages 91-116, January.
  11. Igor Livshits & James MacGee & Michele Tertilt, 2005. "Consumer Bankruptcy: A Fresh Start," Discussion Papers 04-011, Stanford Institute for Economic Policy Research.
  12. Carmen M. Reinhart & Kenneth S. Rogoff & Miguel A. Savastano, 2003. "Debt Intolerance," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 34(1), pages 1-74.
  13. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
  14. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
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