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Debt dilution, overborrowing, and sovereign default risk

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  • Juan Carlos Hatchondo

    (Federal Reserve Bank of Richmond)

  • Cesar Sosa-Padilla

    (University of Maryland)

  • Leonardo Martinez

    (IMF)

Abstract

We propose a sovereign default framework that allows us to quantify the importance of the debt dilution problem in accounting for overborrowing and sovereign default risk. We find that debt dilution accounts for 12% of the mean debt level and almost 100% of the sovereign default risk in the simulations of a baseline model. Even without commitment to future repayment policies and without contingency of sovereign debt, if the sovereign could eliminate the dilution problem, the number of default per 100 years in our simulations decreases from 2.72 with debt dilution to 0.01 without debt dilution. Our analysis is also relevant for the study of other credit markets where the debt dilution problem could appear.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 481.

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Date of creation: 2010
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Handle: RePEc:red:sed010:481

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Web page: http://www.EconomicDynamics.org/society.htm
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  1. Emine Boz & Christian Daude & Ceyhun Bora Durdu, 2008. "Emerging market business cycles revisited: learning about the trend," International Finance Discussion Papers 927, Board of Governors of the Federal Reserve System (U.S.).
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  3. Michael Tomz & Mark L. J. Wright, 2007. "Do Countries Default in "Bad Times" ?," Journal of the European Economic Association, MIT Press, vol. 5(2-3), pages 352-360, 04-05.
  4. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2007. "Quantitative models of sovereign default and the threat of financial exclusion," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 251-286.
  5. Juan M. Sanchez & Horacio Sapriza & Gabriel Cuadra, 2009. "Fiscal Policy and Default Risk in Emerging Markets," 2009 Meeting Papers 701, Society for Economic Dynamics.
  6. repec:acb:camaaa:2009-15 is not listed on IDEAS
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  9. Dirk Niepelt, 2008. "Debt Maturity without Commitment," CESifo Working Paper Series 2500, CESifo Group Munich.
  10. Alfaro, Laura & Kanczuk, Fabio, 2005. "Sovereign debt as a contingent claim: a quantitative approach," Journal of International Economics, Elsevier, vol. 65(2), pages 297-314, March.
  11. Sandra Lizarazo, 2009. "Contagion of Financial Crises in Sovereing Debt Markets," Working Papers 0906, Centro de Investigacion Economica, ITAM.
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  13. Cristina Arellano & Ananth Ramanarayanan, 2008. "Default and the maturity structure in sovereign bonds," Staff Report 410, Federal Reserve Bank of Minneapolis.
  14. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2009. "On the cyclicality of the interest rate in emerging economy models: solution methods matter," Working Paper 09-13, Federal Reserve Bank of Richmond.
  15. Satyajit Chatterjee & Burcu Eyigungor, 2009. "Maturity, Indebtedness, and Default Risk," Koç University-TUSIAD Economic Research Forum Working Papers 0901, Koc University-TUSIAD Economic Research Forum.
  16. Yan Bai & Jing Zhang, 2006. "Financial Integration and International Risk Sharing," 2006 Meeting Papers 371, Society for Economic Dynamics.
  17. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
  18. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2008. "Heterogeneous borrowers in quantitative models of sovereign default," Working Paper 07-01, Federal Reserve Bank of Richmond.
  19. Oren Sussman & Alexander Guembel, 2005. "Sovereign Debt Without Default Penalties," OFRC Working Papers Series 2005fe17, Oxford Financial Research Centre.
  20. Gabriel Cuadra & Horacio Sapriza, 2006. "Sovereign Default, Terms of Trade and Interest Rates in Emerging Markets," Working Papers 2006-01, Banco de México.
  21. Ceyhun Bora Durdu, 2007. "Quantitative Implications of Indexed Bonds in Small Open Economies," 2007 Meeting Papers 482, Society for Economic Dynamics.
  22. Martín Uribe, 2006. "Individual Versus Aggregate Collateral Constraints and the Overborrowing Syndrome," NBER Working Papers 12260, National Bureau of Economic Research, Inc.
  23. Satyajit Chatterjee & Dean Corbae & Makoto Nakajima & Jose-Victor Rios-Rull, 2007. "A quantitative theory of unsecured consumer credit with risk of default," Working Papers 07-16, Federal Reserve Bank of Philadelphia.
  24. Juan M. Sanchez, 2008. "The Role of Information in Consumer Debt and Bankruptcy," 2008 Meeting Papers 523, Society for Economic Dynamics.
  25. Gabriel Cuadra & Horacio Sapriza, 2006. "Sovereign Default, Interest Rates and Political Uncertainty in Emerging Markets," Working Papers 2006-02, Banco de México.
  26. Juan Carlos Hatchondo & Leonardo Martinez, 2009. "Long-duration bonds and sovereign defaults," Working Paper 08-02, Federal Reserve Bank of Richmond.
  27. David Benjamin & Mark L. J. Wright, 2009. "Recovery Before Redemption: A Theory Of Delays In Sovereign Debt Renegotiations," CAMA Working Papers 2009-15, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
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