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Linkages across sovereign debt markets

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  • Yan Bai

    (University of Rochester)

  • Cristina Arellano

    (Federal Reserve Bank of Minneapolis)

Abstract

This paper studies linkages across sovereign debt markets when debt is unenforceable and countries choose to default and renegotiate. In the model countries are linked to one another by borrowing from a common lender. Borrowing from a common lender connects borrowing rates across countries as well as the renegotiation arrangements. Default of one country lowers the lenderÂ’s wealth which in turn increases the borrowing rate for the other countries. Higher interest rates could then lead to a second default and an even lower wealth for the lender. Foreseeing these events, the lender accepts a lenient haircut from the Â…rst defaulter country. The model can rationalize some of the recent events in Europe.

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2012 Meeting Papers with number 414.

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Date of creation: 2012
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Handle: RePEc:red:sed012:414

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  1. 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.
  2. Horn, H. & Wolinsky, A., 1988. "Bilateral Monopolies And Incentives For Merger," Papers 410, Stockholm - International Economic Studies.
  3. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-Fulfilling Debt Crises," Levine's Working Paper Archive 114, David K. Levine.
  4. Fernando A. Broner & R. Gaston Gelos & Carmen M. Reinhart, 2005. "When in Peril, Retrench: Testing the Portfolio Channel of Contagion," Working Papers 207, Barcelona Graduate School of Economics.
  5. Park, JungJae, 2013. "Contagion of Sovereign Default Risk: the Role of Two Financial Frictions," MPRA Paper 55197, University Library of Munich, Germany.
  6. Juan J. Cruces & Christoph Trebesch, 2013. "Sovereign Defaults: The Price of Haircuts," American Economic Journal: Macroeconomics, American Economic Association, vol. 5(3), pages 85-117, July.
  7. Vivian Z. Yue, 2005. "Sovereign Default and Debt Renegotiation," 2005 Meeting Papers 138, Society for Economic Dynamics.
  8. Carmen M. Reinhart & Kenneth S. Rogoff, 2011. "From Financial Crash to Debt Crisis," American Economic Review, American Economic Association, vol. 101(5), pages 1676-1706, August.
  9. 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.
  10. Mark Aguiar & Gita Gopinath, 2004. "Defaultable debt, interest rates, and the current account," Working Papers 04-5, Federal Reserve Bank of Boston.
  11. Arellano, Cristina, 2008. "Default risk and income fluctuations in emerging economies," MPRA Paper 7867, University Library of Munich, Germany.
  12. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
  13. Lizarazo, Sandra Valentina, 2013. "Default risk and risk averse international investors," Journal of International Economics, Elsevier, vol. 89(2), pages 317-330.
  14. Lizarazo, Sandra, 2009. "Contagion of Financial Crises in Sovereign Debt Markets," MPRA Paper 20795, University Library of Munich, Germany, revised 06 Feb 2010.
  15. Van Rijckeghem, Caroline & Weder, Beatrice, 2001. "Sources of contagion: is it finance or trade?," Journal of International Economics, Elsevier, vol. 54(2), pages 293-308, August.
  16. Kaminsky, Graciela L. & Reinhart, Carmen M., 2000. "On crises, contagion, and confusion," Journal of International Economics, Elsevier, vol. 51(1), pages 145-168, June.
  17. Tauchen, George & Hussey, Robert, 1991. "Quadrature-Based Methods for Obtaining Approximate Solutions to Nonlinear Asset Pricing Models," Econometrica, Econometric Society, vol. 59(2), pages 371-96, March.
  18. Adrien Verdelhan & Nicola Borri, 2010. "Sovereign Risk Premia," 2010 Meeting Papers 1122, Society for Economic Dynamics.
  19. Van Rijckeghem, Caroline & Weder, Beatrice, 2003. "Spillovers through banking centers: a panel data analysis of bank flows," Journal of International Money and Finance, Elsevier, vol. 22(4), pages 483-509, August.
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Cited by:
  1. Javier Bianchi & Juan Carlos Hatchondo & Leonardo Martinez, 2013. "International Reserves and Rollover Risk," IMF Working Papers 13/33, International Monetary Fund.
  2. Park, JungJae, 2013. "Contagion of Sovereign Default Risk: the Role of Two Financial Frictions," MPRA Paper 55197, University Library of Munich, Germany.
  3. Saleem Bahaj, 2014. "Systemic Sovereign Risk: Macroeconomic Implications in the Euro Area," Discussion Papers 1406, Centre for Macroeconomics (CFM).

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