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The Sovereign Default Puzzle: Modelling Issues and Lessons for Europe

  • Cohen, Daniel
  • Villemot, Sébastien

Why do countries default? This seemingly simple question has yet to be adequately answered in the literature. Indeed, prevailing modelling strategies compel the to choose between two unappealing model features: depending on the cost of default selected by the modeler, either the debt ratios are too high and the probability of default is too low or the opposite is true. In view of the historical evidence that countries always default after a crisis, we propose a novel approach to the theory of debt default and develop a model that matches the key stylized facts regarding sovereign risk.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 8971.

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Date of creation: May 2012
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Handle: RePEc:cpr:ceprdp:8971
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