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Sovereign Defaults and Banking Crises

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  • Sosa-Padilla, Cesar

Abstract

Episodes of sovereign default feature three key empirical regularities in connection with the banking systems of the countries where they occur: (i) sovereign defaults and banking crises tend to happen together, (ii) commercial banks have substantial holdings of government debt, and (iii) sovereign defaults result in major contractions in bank credit and production. This paper provides a rationale for these phenomena by extending the traditional sovereign default framework to incorporate bankers that lend to both the government and the corporate sector. When these bankers are highly exposed to government debt a default triggers a banking crisis which leads to a corporate credit collapse and subsequently to an output decline. When calibrated to Argentina's 2001 default episode the model produces default on equilibrium with a frequency in line with actual default frequencies, and when it happens credit experiences a sharp contraction which generates an output drop similar in magnitude to the one observed in the data. Moreover, the model also matches several moments of the cyclical dynamics of macroeconomic aggregates.

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Bibliographic Info

Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 41074.

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Date of creation: 2012
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Handle: RePEc:pra:mprapa:41074

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Keywords: Sovereign Default; Banking Crisis; Credit Crunch; Optimal Fiscal Policy; Markov Perfect Equilibrium; Endogenous Cost of Default; Domestic Debt;

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  1. Hatchondo, Juan Carlos & Martinez, Leonardo, 2009. "Long-duration bonds and sovereign defaults," Journal of International Economics, Elsevier, vol. 79(1), pages 117-125, September.
  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. Carmen M. Reinhart & Kenneth S. Rogoff, 2008. "The Forgotten History of Domestic Debt," NBER Working Papers 13946, National Bureau of Economic Research, Inc.
  4. Michael Kumhof & Evan Tanner, 2005. "Government Debt: A Key Role in Financial Intermediation," IMF Working Papers 05/57, International Monetary Fund.
  5. Satyajit Chatterjee & Burcu Eyigungor, 2012. "Maturity, Indebtedness, and Default Risk," American Economic Review, American Economic Association, vol. 102(6), pages 2674-99, October.
  6. Ravn, M.O. & Uhlig, H., 2002. "On adjusting the Hodrick-Prescott Filter for the frequency of observations," Open Access publications from University College London http://discovery.ucl.ac.u, University College London.
  7. Nicola Gennaioli & Alberto Martin & Stefano Rossi, 2012. "Sovereign Default, Domestic Banks, and Financial Institutions," Working Papers 462, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
  8. S. Rao Aiyagari & Albert Marcet & Thomas J. Sargent & Juha Seppala, 2002. "Optimal Taxation without State-Contingent Debt," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1220-1254, December.
  9. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973.
  10. Juan Carlos Hatchondo & Leonardo Martinez, 2012. "Debt dilution and sovereign default risk," Working Paper 10-08, Federal Reserve Bank of Richmond.
  11. Chakraborty, Suparna, 2009. "Modeling sudden stops: The non-trivial role of preference specifications," Economics Letters, Elsevier, vol. 104(1), pages 1-4, July.
  12. Carmen M. Reinhart & Kenneth S. Rogoff, 2010. "From Financial Crash to Debt Crisis," NBER Working Papers 15795, National Bureau of Economic Research, Inc.
  13. Carmen M. Reinhart, 2010. "This Time is Different Chartbook: Country Histories on Debt, Default, and Financial Crises," NBER Working Papers 15815, National Bureau of Economic Research, Inc.
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  1. Sovereign Defaults and Banking Crises
    by Christian Zimmermann in NEP-DGE blog on 2012-09-16 23:42:26

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