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Dynamics of investment, debt, and default

Author Info

Listed author(s):
  • Grey Gordon
  • Pablo Guerrón-Quintana

Abstract

How does physical capital accumulation affect the decision to default in developing small open economies? We find that, conditional on a level of foreign indebtedness, more capital improves the sovereign’s ability to meet its obligations, reducing the likelihood of default and the risk premium. This effect, however, is diminishing in the stock of capital because capital also tames the severity of the contraction following default, making autarky more appealing. Access to long-term debt and costly capital adjustment are crucial for matching business cycles. Our quantitative model delivers default episodes that mimic those observed in the data.

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File URL: http://www.philadelphiafed.org/research-and-data/publications/working-papers/2013/wp13-18.pdf
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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 13-18.

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Date of creation: 2013
Handle: RePEc:fip:fedpwp:13-18
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Keywords: Investments ; Debt ; Default (Finance);

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Cited by:

  1. Park, JungJae, 2011. "Sovereign Default and Capital Accumulation," MPRA Paper 60150, University Library of Munich, Germany, revised Nov 2014.
  2. Kollintzas, Tryphon & Tsoukalas, Konstantinos, 2015. "Bank and Sovereign Risk Interdependence in the Euro Area," CEPR Discussion Papers 10485, C.E.P.R. Discussion Papers.

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