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Distributional Incentives In An Equilibrium Model Of Domestic Sovereign Default

Listed author(s):
  • Pablo D'Erasmo
  • Enrique G. Mendoza

Europe’s debt crisis resembles historical episodes of outright default on domestic public debt about which little research exists. This paper proposes a theory of domestic sovereign default based on distributional incentives affecting the welfare of risk-averse debt- and non-debt holders. A utilitarian government cannot sustain debt if default is costless. If default is costly, debt with default risk is sustainable, and debt falls as concentration of debt ownership rises. A government favoring bond holders can also sustain debt, with debt rising as ownership becomes more concentrated. These results are robust to adding foreign investors, redistributive taxes, or a second asset.

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File URL: http://hdl.handle.net/10.1111/jeea.2016.14.issue-1
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Article provided by European Economic Association in its journal Journal of the European Economic Association.

Volume (Year): 14 (2016)
Issue (Month): 1 (February)
Pages: 7-44

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Handle: RePEc:bla:jeurec:v:14:y:2016:i:1:p:7-44
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