Advanced Search
MyIDEAS: Login to save this paper or follow this series

Country Risk and Incentives Schemes

Contents:

Author Info

  • Joshua Aizenman

Abstract

The purpose of this paper is to address the role of endogenous default penalties that are contingent upon the intensity of default on the part of the borrowing nation, and to evaluate the effects of contingency plans that make the interest rate dependent upon variables that are correlated with the default penalty. This is done by considering an economy where a default will trigger a variable cost whose magnitude is determined by the intensity of default. We design alternative incentive schemes by varying the responsiveness of the penalty to the intensity of default, without changing the total cost applied in case of a complete default. At the limit our incentive scheme converges to an exogenous default cost regime. We derive the supply of credit for the case where there is uncertainty regarding the total default cost, and we evaluate the dependency of the supply curve on the incentive scheme. A rise in the elasticity of the penalty with respect to the default intensity is shown to induce a higher default rate and to raise the country risk as reflected in the interest rate associated with a given borrowing, causing a leftward shift in the supply of credit. Using the expected welfare of a representative consumer it is shown that the introduction of partial defaults due to a variable penalty has adverse effects. Thus, our study concludes that variable default schemes that tie the penalty to the default rate are disadvantageous. We turn then to an assessment of the welfare effect of plans that make the interest rate contingent upon realization of shocks. In general, such a contingency plan is advantageous. For example, a plan that will index the Interest rate such as to correlate it perfectly with the default penalty eliminates the adverse effects of country risk on expected income. For such an economy a contingency plan that will index the effective interest rate to the realization of the terms of trade will be beneficial in reducing the effective magnitude of country risk and the incidence of default .

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.nber.org/papers/w2031.pdf
Download Restriction: no

Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2031.

as in new window
Length:
Date of creation: Sep 1986
Date of revision:
Publication status: Published as "Country Risk and Contingencies", International Economic Journal, Vol. 3, no. 1 (1989): 81-102.
Handle: RePEc:nbr:nberwo:2031

Note: ITI IFM
Contact details of provider:
Postal: National Bureau of Economic Research, 1050 Massachusetts Avenue Cambridge, MA 02138, U.S.A.
Phone: 617-868-3900
Email:
Web page: http://www.nber.org
More information through EDIRC

Related research

Keywords:

References

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.:
as in new window
  1. Eaton, Jonathan, 1986. "Lending with costly enforcement of repayment and potential fraud," Journal of Banking & Finance, Elsevier, Elsevier, vol. 10(2), pages 281-293, June.
  2. Kletzer, Kenneth M, 1984. "Asymmetries of Information and LDC Borrowing with Sovereign Risk," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 94(374), pages 287-307, June.
  3. Sebastian Edwards, 1983. "LDC's Foreign Borrowing and Default Risk: An Empirical Investigation," NBER Working Papers 1172, National Bureau of Economic Research, Inc.
  4. Aizenman, Joshua, 1989. "Country Risk, Incomplete Information and Taxes on International Borrowing," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 99(394), pages 147-61, March.
  5. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 48(2), pages 289-309, April.
Full references (including those not matched with items on IDEAS)

Citations

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:nbr:nberwo:2031. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: ().

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.