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Managing Default Risk

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  • Anna Zabai

Abstract

High sovereign debt in advanced economies has recently revived the debate about the role of coordination problems and self-fulfilling beliefs as drivers of sovereign default risk. I show how default risk can be decomposed in a solvency-risk component and a coordination-risk component. I then study how fiscal policy can be effective in managing the risk of coordination and I characterise how the shape of the optimal policy is affected by the presence of this risk: making the deficit contingent on interest rate movements is more effective in managing default risk than using non-contingent fiscal targets.

Suggested Citation

  • Anna Zabai, 2014. "Managing Default Risk," BIS Working Papers 467, Bank for International Settlements.
  • Handle: RePEc:bis:biswps:467
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    References listed on IDEAS

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    1. Aleh Tsyvinski & Arijit Mukherji & Christian Hellwig, 2006. "Self-Fulfilling Currency Crises: The Role of Interest Rates," American Economic Review, American Economic Association, vol. 96(5), pages 1769-1787, December.
    2. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "Varieties of Crises and Their Dates," Introductory Chapters, in: This Time Is Different: Eight Centuries of Financial Folly, Princeton University Press.
    3. George-Marios Angeletos & Christian Hellwig & Alessandro Pavan, 2006. "Signaling in a Global Game: Coordination and Policy Traps," Journal of Political Economy, University of Chicago Press, vol. 114(3), pages 452-484, June.
    4. Morris, Stephen & Shin, Hyun Song, 1998. "Unique Equilibrium in a Model of Self-Fulfilling Currency Attacks," American Economic Review, American Economic Association, vol. 88(3), pages 587-597, June.
    5. Iván Werning & George-Marios Angeletos, 2006. "Crises and Prices: Information Aggregation, Multiplicity, and Volatility," American Economic Review, American Economic Association, vol. 96(5), pages 1720-1736, December.
    6. Grossman, Sanford J & Stiglitz, Joseph E, 1976. "Information and Competitive Price Systems," American Economic Review, American Economic Association, vol. 66(2), pages 246-253, May.
    7. Morris, Stephen & Shin, Hyun Song, 2004. "Coordination risk and the price of debt," European Economic Review, Elsevier, vol. 48(1), pages 133-153, February.
    8. Calvo, Guillermo A, 1988. "Servicing the Public Debt: The Role of Expectations," American Economic Review, American Economic Association, vol. 78(4), pages 647-661, September.
    9. Harold L. Cole & Timothy J. Kehoe, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Oxford University Press, vol. 67(1), pages 91-116.
    10. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
    11. Paul De Grauwe & Yuemei Ji, 2012. "Mispricing of Sovereign Risk and Multiple Equilibria in the Eurozone," LICOS Discussion Papers 30412, LICOS - Centre for Institutions and Economic Performance, KU Leuven.
    12. Nikola A. Tarashev, 2007. "Speculative Attacks and the Information Role of the Interest Rate," Journal of the European Economic Association, MIT Press, vol. 5(1), pages 1-36, March.
    13. Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 289-309.
    14. Albert S. Kyle, 1989. "Informed Speculation with Imperfect Competition," Review of Economic Studies, Oxford University Press, vol. 56(3), pages 317-355.
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    Cited by:

    1. Szkup, Michal, 2017. "Preventing Self-fulfilling debt crises," MPRA Paper 82754, University Library of Munich, Germany.
    2. Szkup, Michal, 0. "Multiplier effect and comparative statics in global games of regime change," Theoretical Economics, Econometric Society.
    3. Angeletos, G.-M. & Lian, C., 2016. "Incomplete Information in Macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & Harald Uhlig (ed.),Handbook of Macroeconomics, edition 1, volume 2, chapter 0, pages 1065-1240, Elsevier.

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    Keywords

    Default risk; fiscal policy; coordination; global games.;

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