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Sovereign debt issuance and selective default

Author

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  • Shakhnov, Kirill
  • Paczos, Wojtek

Abstract

Sovereigns issue debt on both domestic and foreign markets and when they default, they default mostly selectively. We propose a theory to rationalize these observations. A government chooses the optimal combination of two debts to smooth consumption, which is subject to output shock and volatile tax distortions. In equilibrium, it mostly relies on domestic debt to smooth the tax wedge and on foreign debt to smooth the output shock. Issuing either debt is less costly than raising taxes, but it is subject to default risk due to the government’s limited commitment. A quantitative, calibrated model with two shocks and two debts replicates well debt-to-GDP ratios, default frequencies, cyclical properties of emerging economies and behavior of aggregates around default episodes.

Suggested Citation

  • Shakhnov, Kirill & Paczos, Wojtek, 2026. "Sovereign debt issuance and selective default," Macroeconomic Dynamics, Cambridge University Press, vol. 30, pages 1-19, January.
  • Handle: RePEc:cup:macdyn:v:30:y:2026:i::p:-_19
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    Cited by:

    1. is not listed on IDEAS
    2. Erce, Aitor & Picarelli, Mattia & Mallucci, Enrico, 2024. "Sovereign Defaults at Home and Abroad," CEPR Discussion Papers 18739, Centre for Economic Policy Research.
    3. Aitor Erce, 2012. "Selective sovereign defaults," Globalization Institute Working Papers 127, Federal Reserve Bank of Dallas.
    4. Demian Pouzo & Ignacio Presno, 2020. "Optimal Taxation with Endogenous Default under Incomplete Markets," International Finance Discussion Papers 1297, Board of Governors of the Federal Reserve System (U.S.).
    5. Dirk Niepelt, 2016. "Domestic and External Debt and Default," 2016 Meeting Papers 635, Society for Economic Dynamics.
    6. Keyser, Alice & Paczos, Wojtek, 2023. "Sovereign risk, debt composition and exchange rate regimes," Finance Research Letters, Elsevier, vol. 58(PB).
    7. Paczos, Wojtek & Shakhnov, Kirill, 2022. "Defaulting on Covid debt," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 77(C).
    8. Kirill Shakhnov & Nicola Borri, 2017. "Limited Arbitrage in the Market for Local Currency Emerging Market Debt," 2017 Meeting Papers 737, Society for Economic Dynamics.
    9. D’Erasmo, Pablo & Mendoza, Enrique G., 2021. "History remembered: Optimal sovereign default on domestic and external debt," Journal of Monetary Economics, Elsevier, vol. 117(C), pages 969-989.

    More about this item

    JEL classification:

    • E43 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Interest Rates: Determination, Term Structure, and Effects
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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