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Linkages across sovereign debt markets

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Author Info

  • 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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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Web page: http://www.EconomicDynamics.org/society.htm
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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. Arellano, Cristina, 2008. "Default risk and income fluctuations in emerging economies," MPRA Paper 7867, University Library of Munich, Germany.
  3. Vivian Z. Yue, 2005. "Sovereign Default and Debt Renegotiation," 2005 Meeting Papers 138, Society for Economic Dynamics.
  4. Lizarazo, Sandra, 2009. "Contagion of Financial Crises in Sovereign Debt Markets," MPRA Paper 20795, University Library of Munich, Germany, revised 06 Feb 2010.
  5. Aguiar, Mark & Gopinath, Gita, 2006. "Defaultable debt, interest rates and the current account," Journal of International Economics, Elsevier, vol. 69(1), pages 64-83, June.
  6. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
  7. Lizarazo, Sandra Valentina, 2013. "Default risk and risk averse international investors," Journal of International Economics, Elsevier, vol. 89(2), pages 317-330.
  8. Adrien Verdelhan & Nicola Borri, 2010. "Sovereign Risk Premia," 2010 Meeting Papers 1122, Society for Economic Dynamics.
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Cited by:
  1. Javier Bianchi & Juan Carlos Hatchondo & Leonardo Martinez, 2012. "International Reserves and Rollover Risk," NBER Working Papers 18628, National Bureau of Economic Research, Inc.
  2. Park, JungJae, 2013. "Contagion of Sovereign Default Risk: the Role of Two Financial Frictions," MPRA Paper 55197, University Library of Munich, Germany.

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