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Optimal external debt and default

  • Guimarães, Bernardo

This paper analyses whether sovereign default episodes can be seen as contingencies of optimal international lending contracts. The model considers a small open economy with capital accumulation and without commitment to repay debt. Taking first order approximations of Bellman equations, I derive analytical expressions for the equilibrium level of debt and the optimal debt contract. In this environment, debt relief generated by reasonable fluctuations in productivity is an order of magnitude below that generated by shocks to world interest rates. Debt relief prescribed by the model following the interest rate hikes of 1980-81 accounts for a substantial part of the debt forgiveness obtained by the main Latin American countries through the Brady agreements.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 6035.

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Date of creation: Jan 2007
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Handle: RePEc:cpr:ceprdp:6035
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  1. Uribe, Martin & Yue, Vivian Z., 2006. "Country spreads and emerging countries: Who drives whom?," Journal of International Economics, Elsevier, vol. 69(1), pages 6-36, June.
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  15. Herschel I. Grossman & John B. Van Huyck, 1985. "Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation," NBER Working Papers 1673, National Bureau of Economic Research, Inc.
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  17. Natalia Kovrijnykh & Balázs Szentes, 2007. "Equilibrium Default Cycles," Journal of Political Economy, University of Chicago Press, vol. 115, pages 403-446.
  18. Jeremy I. Bulow & Kenneth Rogoff, 1986. "A Constant Recontracting Model of Sovereign Debt," NBER Working Papers 2088, National Bureau of Economic Research, Inc.
  19. William R. Zame, 1990. "Efficiency and the Role of Default When Security Markets are Incomplete," UCLA Economics Working Papers 585, UCLA Department of Economics.
  20. Mark Aguiar & Gita Gopinath, 2004. "Defaultable debt, interest rates and the current account," Proceedings, Federal Reserve Bank of San Francisco, issue Jun.
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  31. repec:rus:hseeco:123922 is not listed on IDEAS
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