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Dynamics of Investment, Debt, and Default

Author

Listed:
  • Grey Gordon

    (Indiana University)

  • Pablo Guerron-Quintana

    (Boston College)

Abstract

This paper proposes a sovereign default model with long-term debt and endogenous output and investment that simultaneously accounts for default episodes and business cycles in emerging economies. In response to positive productivity shocks, risk premia fall and the sovereign borrows to finance investment. When adverse productivity shocks make international borrowing expensive, the sovereign responds by rolling over debt and reducing investment. This causes output to fall and the debt-output ratio to increase, and default occurs if the negative shocks continue long enough. Consequently, the model generates first an increase and then a decrease in investment, consumption, and output prior to default, as in the data. These relationships between productivity, spreads, investment, and borrowing also make the model consistent with many features of small open economy business cycles such as countercyclical spreads and net exports. While capital has non-trivial effects on the incentive to default, increased capital almost always reduces risk premia in equilibrium. (Copyright: Elsevier)

Suggested Citation

  • Grey Gordon & Pablo Guerron-Quintana, 2018. "Dynamics of Investment, Debt, and Default," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 28, pages 71-95, April.
  • Handle: RePEc:red:issued:14-216
    DOI: 10.1016/j.red.2017.07.007
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    Citations

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    Cited by:

    1. Park, JungJae, 2011. "Sovereign Default and Capital Accumulation," MPRA Paper 60150, University Library of Munich, Germany, revised Nov 2014.
    2. Aguiar, M. & Chatterjee, S. & Cole, H. & Stangebye, Z., 2016. "Quantitative Models of Sovereign Debt Crises," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.),Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 1697-1755, Elsevier.
    3. Alessandria, George & Bai, Yan & Deng, Minjie, 2020. "Migration and sovereign default risk," Journal of Monetary Economics, Elsevier, vol. 113(C), pages 1-22.
    4. Tavares, Tiago, 2019. "Labor market distortions under sovereign debt default crises," Journal of Economic Dynamics and Control, Elsevier, vol. 108(C).
    5. Arellano, Cristina & Bai, Yan & Mihalache, Gabriel, 2018. "Default risk, sectoral reallocation, and persistent recessions," Journal of International Economics, Elsevier, vol. 112(C), pages 182-199.
    6. Phan, Toan, 2017. "A model of sovereign debt with private information," Journal of Economic Dynamics and Control, Elsevier, vol. 83(C), pages 1-17.
    7. Ram Yamarthy, 2019. "Corporate Debt Maturity and the Real Economy," 2019 Meeting Papers 627, Society for Economic Dynamics.
    8. Grey Gordon & Pablo Guerron-Quintana, 2019. "A Quantitative Theory of Hard and Soft Sovereign Defaults," 2019 Meeting Papers 412, Society for Economic Dynamics.
    9. Yongquan Cao & Grey Gordon, 2019. "A Practical Approach to Testing Calibration Strategies," Computational Economics, Springer;Society for Computational Economics, vol. 53(3), pages 1165-1182, March.
    10. Park, JungJae, 2017. "Sovereign default and capital accumulation," Journal of International Economics, Elsevier, vol. 106(C), pages 119-133.
    11. Mihalache, Gabriel, 2020. "Sovereign default resolution through maturity extension," Journal of International Economics, Elsevier, vol. 125(C).
    12. Dominik Thaler, 2018. "Sovereign default, domestic banks and exclusion from international capital markets," Working Papers 1824, Banco de España;Working Papers Homepage.
    13. Marios Karabarbounis & Patrick Macnamara, 2019. "Misallocation and Credit Market Constraints: the Role of Long-Term Financing," Working Paper 19-1, Federal Reserve Bank of Richmond, revised 16 Jan 2019.
    14. Siming Liu & Hewei Shen, 2018. "Fiscal Commitment and Sovereign Default Risk," CAEPR Working Papers 2018-003, Center for Applied Economics and Policy Research, Department of Economics, Indiana University Bloomington.
    15. Grey Gordon & Pablo Guerron-Quintana, 2018. "Dynamics of Investment, Debt, and Default," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 28, pages 71-95, April.
    16. Carlo Galli, 2019. "Self-Fulfilling Debt Crises, Fiscal Policy and Investment," Discussion Papers 1904, Centre for Macroeconomics (CFM).
    17. Guerron-Quintana, Pablo A., 2020. "“Migration and sovereign default risk” a comment," Journal of Monetary Economics, Elsevier, vol. 113(C), pages 23-27.
    18. Kollintzas, Tryphon & Tsoukalas, Konstantinos, 2015. "Bank and Sovereign Risk Interdependence in the Euro Area," CEPR Discussion Papers 10485, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

    Investment; Debt; Default; Long-term debt;

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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