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Dynamics of investment, debt, and default

Author

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  • 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.

Suggested Citation

  • 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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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

    Citations

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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. Yongquan Cao & Grey Gordon, 2016. "A Practical Approach to Testing Calibration Strategies," Caepr Working Papers 2016-004 Classification-C, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
    3. repec:eee:macchp:v2-1697 is not listed on IDEAS
    4. Cristina Arellano & Yan Bai & Gabriel Mihalache, 2017. "Default Risk, Sectoral Reallocation, and Persistent Recessions," NBER Chapters,in: NBER International Seminar on Macroeconomics 2017 National Bureau of Economic Research, Inc.
    5. Aguiar, M. & Chatterjee, S. & Cole, H. & Stangebye, Z., 2016. "Quantitative Models of Sovereign Debt Crises," Handbook of Macroeconomics, Elsevier.
    6. repec:eee:dyncon:v:83:y:2017:i:c:p:1-17 is not listed on IDEAS
    7. Kollintzas, Tryphon & Tsoukalas, Konstantinos, 2015. "Bank and Sovereign Risk Interdependence in the Euro Area," CEPR Discussion Papers 10485, C.E.P.R. Discussion Papers.

    More about this item

    Keywords

    Investments ; Debt ; Default (Finance);

    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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