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Dynamics of investment, debt, and default

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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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  • Grey Gordon & Pablo Guerrón-Quintana, 2013. "Dynamics of investment, debt, and default," Working Papers 13-18, Federal Reserve Bank of Philadelphia.
    • Handle: RePEc:fip:fedpwp:13-18
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    More about this item

    Keywords

    Investments; Debt; Default (Finance);
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F41 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Open Economy Macroeconomics
    • F44 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - International Business Cycles

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