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Optimal costs of sovereign default

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  • Leonardo Pio Perez

Abstract

I apply a standard model of sovereign debt in order to identify the optimal costs of default from the ex-ante point of view of the borrower. I depart from the literature by distinguishing events of strong economic crises from standard business cycles. Crisis events seem to be appropriate moments in which the option to default might be welfare improving by providing state contingency in the debt contract. The quantitative analysis shows that the costs of default should be limited, leaving default as an option, but at much higher levels than the ones consistent with the observed debt-output and default ratios of emerging economies. The results in this paper have implication on the evolution of sovereign debt workout procedures and the potential demand for new debt instruments.

Suggested Citation

  • Leonardo Pio Perez, 2011. "Optimal costs of sovereign default," Working Papers Series 236, Central Bank of Brazil, Research Department.
  • Handle: RePEc:bcb:wpaper:236
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    File URL: https://www.bcb.gov.br/pec/wps/ingl/wps236.pdf
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    Cited by:

    1. Tabak, Benjamin M. & Takami, Marcelo & Rocha, Jadson M.C. & Cajueiro, Daniel O. & Souza, Sergio R.S., 2014. "Directed clustering coefficient as a measure of systemic risk in complex banking networks," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 394(C), pages 211-216.
    2. Ornelas, José Renato Haas & Barbachan, José Santiago Fajardo & Farias, Aquiles Rocha de, 2012. "Estimating relative risk aversion, risk-neutral and real-world densities using brazilian real currency options," EBAPE Working Papers 1, FGV EBAPE - Escola Brasileira de Administração Pública e de Empresas (Brazil).

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