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The sources of sovereign risk: a calibration based on Lévy stochastic processes

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  • Carré, Sylvain
  • Cohen, Daniel
  • Villemot, Sébastien

Abstract

Governments choose to issue risky or riskless debt depending on the nature of the stochastic process of output. We use Brownian motion and Poisson shocks—a modeling method in the literature on corporate default known as Lévy processes—to approximate a decomposition of the output process into a smooth and a jump component. Using an Eaton and Gersovitz (1981) model of debt repudiation, we show that the Brownian part explains the counter-cyclical behavior of the current account, and the Poisson part explains the risk of default—thus enabling our model to account for key stylized facts regarding sovereign risk.

Suggested Citation

  • Carré, Sylvain & Cohen, Daniel & Villemot, Sébastien, 2019. "The sources of sovereign risk: a calibration based on Lévy stochastic processes," Journal of International Economics, Elsevier, vol. 118(C), pages 31-43.
    • Handle: RePEc:eee:inecon:v:118:y:2019:i:c:p:31-43
    DOI: 10.1016/j.jinteco.2019.02.003
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    Cited by:

    1. Perazzi, Elena, 2020. "Sovereign Bailouts and Moral Hazard with Strategic Default," MPRA Paper 101949, University Library of Munich, Germany.

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    More about this item

    Keywords

    Sovereign debt; Default;

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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