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Sovereign Risk and Secondary Markets

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Author Info
Fernando Broner
Alberto Martin
Jaume Ventura

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Abstract

Conventional wisdom says that, in the absence of sufficient default penalties, sovereign risk constrains credit and lowers welfare. We show that this conventional wisdom rests on one implicit assumption: that assets cannot be retraded in secondary markets. Once this assumption is relaxed, there is always an equilibrium in which sovereign risk is stripped of its conventional effects. In such an equilibrium, foreigners hold domestic debts and resell them to domestic residents before enforcement. In the presence of (even arbitrarily small) default penalties, this equilibrium is shown to be unique. As a result, sovereign risk neither constrains welfare nor lowers credit. At most, it creates some additional trade in secondary markets. The results presented here suggest a change in perspective regarding the origins of sovereign risk and its remedies. To argue that sovereign risk constrains credit, one must show both the insufficiency of default penalties and the imperfect workings of secondary markets. To relax credit constraints created by sovereign risk, one can either increase default penalties or improve the workings of secondary markets.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12783.

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Date of creation: Dec 2006
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Handle: RePEc:nbr:nberwo:12783

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Find related papers by JEL classification:
F34 - International Economics - - International Finance - - - International Lending and Debt Problems
F36 - International Economics - - International Finance - - - Financial Aspects of Economic Integration
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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  15. Detragiache, Enrica, 1994. "Sensible buybacks of sovereign debt," Journal of Development Economics, Elsevier, vol. 43(2), pages 317-333, April. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Bernardo Guimaraes, 2008. "Optimal External Debt and Default," CEP Discussion Papers dp0847, Centre for Economic Performance, LSE. [Downloadable!]
    Other versions:
  2. Michael Tomz & Mark L. J. Wright, 2008. "Sovereign Theft: Theory And Evidence About Sovereign Default And Expropriation," CAMA Working Papers 2008-07, Australian National University, Centre for Applied Macroeconomic Analysis. [Downloadable!]
  3. Fernando Broner & Alberto Martin & Jaume Ventura, 2007. "Enforcement Problems and Secondary Markets," Economics Working Papers 1049, Department of Economics and Business, Universitat Pompeu Fabra. [Downloadable!]
    Other versions:
  4. Albert Marcet & Elisa Faraglia & Andrew Scott, 2008. "In Search of a Theory of Debt Management," UFAE and IAE Working Papers 743.08, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC). [Downloadable!]
    Other versions:
  5. Rohan Pitchford & Mark L. J. Wright, 2008. "Holdouts In Sovereign Debt Restructuring: A Theory Of Negotiation In A Weak Contractual Environment," CAMA Working Papers 2008-37, Australian National University, Centre for Applied Macroeconomic Analysis. [Downloadable!]
  6. Brutti, Filippo, 2008. "Legal enforcement, public supply of liquidity and sovereign risk," MPRA Paper 13949, University Library of Munich, Germany. [Downloadable!]
  7. Cooper, R. & Kempf, H. & Peled, D., 2007. "Regional Debt in Monetary Unions: Is it Inflationary?," Documents de Travail 186, Banque de France. [Downloadable!]
    Other versions:
  8. Yeyati, Eduardo Levy & Schmukler, Sergio L. & Van Horen, Neeltje, 2007. "Emerging market liquidity and crises," Policy Research Working Paper Series 4445, The World Bank. [Downloadable!]
    Other versions:
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