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Partial Default

Author

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  • Cristina Arellano
  • Xavier Mateos-Planas
  • Jose-Victor Rios-Rull

Abstract

In the data sovereign default is always partial and varies in its duration. Debt levels during default episodes initially increase and do not experience reductions upon resolution. This paper presents a theory of sovereign default that replicates these properties, which are absent in standard sovereign default theory. Partial default is a flexible way to raise funds as the sovereign chooses its intensity and duration. Partial default is also costly because it amplifies debt crises as the defaulted debt accumulates and interest rate spreads increase. This theory is capable of rationalizing the large heterogeneity in partial default, its comovements with spreads, debt levels, and output, and the dynamics of debt during default episodes. In our theory, as in the data, debt grows during default episodes, and large defaults are longer, and associated with higher interest rate spreads, higher debt levels, and deeper recessions.

Suggested Citation

  • Cristina Arellano & Xavier Mateos-Planas & Jose-Victor Rios-Rull, 2019. "Partial Default," Staff Report 589, Federal Reserve Bank of Minneapolis.
  • Handle: RePEc:fip:fedmsr:589
    DOI: 10.21034/sr.589
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    References listed on IDEAS

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    Cited by:

    1. Silvia Marchesi & Tania Masi, 2020. "The price of haircuts: private and official default," Development Working Papers 460, Centro Studi Luca d'Agliano, University of Milano, revised 06 Feb 2020.
    2. Péter Benczúr & Cosmin L. Ilut, 2016. "Evidence for Relational Contracts in Sovereign Bank Lending," Journal of the European Economic Association, European Economic Association, vol. 14(2), pages 375-404.
    3. Cristina Arellano & Yan Bai & Gabriel Mihalache, 2020. "Deadly Debt Crises: COVID-19 in Emerging Markets," Staff Report 603, Federal Reserve Bank of Minneapolis.
    4. Gong Cheng & Javier Diaz-Cassou & Aitor Erce, 2019. "The macroeconomic effects of official debt restructuring: evidence from the Paris Club," Oxford Economic Papers, Oxford University Press, vol. 71(2), pages 344-363.
    5. 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.
    6. Lorenzo Esposito & Giuseppe Mastromatteo, 2019. "Defaultnomics: Making Sense of the Barro-Ricardo Equivalence in a Financialized World," Economics Working Paper Archive wp_933, Levy Economics Institute.
    7. Tamon Asonuma & Christoph Trebesch, 2016. "Sovereign Debt Restructurings: Preemptive Or Post-Default," Journal of the European Economic Association, European Economic Association, vol. 14(1), pages 175-214, February.
    8. Kieran Walsh, 2014. "Portfolio Choice and Partial Default in Emerging Markets: a quantitative analysis," 2014 Meeting Papers 789, Society for Economic Dynamics.
    9. Trebesch, Christoph & Zabel, Michael, 2017. "The output costs of hard and soft sovereign default," European Economic Review, Elsevier, vol. 92(C), pages 416-432.
    10. Mark Wright, 2018. "The Seniority Structure of Sovereign Debt," 2018 Meeting Papers 928, Society for Economic Dynamics.
    11. Marchesi, Silvia & Masi, Tania, 2021. "Life after default. Private and official deals," Journal of International Money and Finance, Elsevier, vol. 113(C).
    12. Andreasen, Eugenia, 2015. "Sovereign default, enforcement and the private cost of capital," International Review of Economics & Finance, Elsevier, vol. 39(C), pages 411-427.
    13. Mitchener, Kris & Trebesch, Christoph, 2021. "Sovereign debt in the 21st century: Looking backward, looking forward," Kiel Working Papers 2198, Kiel Institute for the World Economy (IfW Kiel).
    14. Xavier Mateos-Planas & Giulio Seccia, 2014. "Consumer default with complete markets: default-based pricing and finite punishment," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 56(3), pages 549-583, August.
    15. Tamon Asonuma & Hyungseok Joo, 2021. "Public Capital and Fiscal Constraint in Sovereign Debt Crises," School of Economics Discussion Papers 0621, School of Economics, University of Surrey.

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    More about this item

    Keywords

    Emerging markets; Default episodes; Debt restructuring; Debt crises; Sovereign risk;
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt
    • G01 - Financial Economics - - General - - - Financial Crises

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