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Estimating Sovereign Default Risk

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  • Huixin Bi
  • Nora Traum

Abstract

This paper uses Bayesian methods to estimate the sovereign default probability for Greece and Italy in the post-EMU period. We build a real business cycle model that allows for interactions among fiscal policy instruments, sovereign default risk, and a "fiscal limit," which measures the maximum level of debt the government is willing to finance. We estimate the full nonlinear model using likelihood inference methods. Although we find that Greece historically had a lower default probability than Italy for a given debt level, our estimates suggest that the Italian government is more willing to service debt than the Greek government.

Suggested Citation

  • Huixin Bi & Nora Traum, 2012. "Estimating Sovereign Default Risk," American Economic Review, American Economic Association, vol. 102(3), pages 161-166, May.
    • Handle: RePEc:aea:aecrev:v:102:y:2012:i:3:p:161-66
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    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/aer.102.3.161
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    References listed on IDEAS

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    1. Bi, Huixin, 2012. "Sovereign default risk premia, fiscal limits, and fiscal policy," European Economic Review, Elsevier, vol. 56(3), pages 389-410.
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