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The sources of sovereign risk: a calibration based on Lévy stochastic processes

Author

Listed:
  • Sylvain Carré

    (Swiss Finance Institute [Geneva] - Swiss Finance Institute, EPFL - Ecole Polytechnique Fédérale de Lausanne)

  • Daniel Cohen

    (PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - EHESS - École des hautes études en sciences sociales - ENPC - École nationale des ponts et chaussées - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, CEPR - Center for Economic Policy Research)

  • Sébastien Villemot

    (PSE - Paris School of Economics - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - EHESS - École des hautes études en sciences sociales - ENPC - École nationale des ponts et chaussées - CNRS - Centre National de la Recherche Scientifique - INRAE - Institut National de Recherche pour l’Agriculture, l’Alimentation et l’Environnement, PJSE - Paris Jourdan Sciences Economiques - UP1 - Université Paris 1 Panthéon-Sorbonne - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres - INRA - Institut National de la Recherche Agronomique - EHESS - École des hautes études en sciences sociales - ENPC - École nationale des ponts et chaussées - CNRS - Centre National de la Recherche Scientifique, CEPREMAP - Centre pour la recherche économique et ses applications - ECO ENS-PSL - Département d'économie de l'ENS-PSL - ENS-PSL - École normale supérieure - Paris - PSL - Université Paris Sciences et Lettres)

Abstract

Governments choose to issue risky or riskless debt depending on the nature of the stochastic process of output. We use Brownian motion and Poisson shocks—a modeling method in the literature on corporate default known as Lévy processes—to approximate a decomposition of the output process into a smooth and a jump component. Using an Eaton and Gersovitz (1981) model of debt repudiation, we show that the Brownian part explains the counter-cyclical behavior of the current account, and the Poisson part explains the risk of default—thus enabling our model to account for key stylized facts regarding sovereign risk.

Suggested Citation

  • Sylvain Carré & Daniel Cohen & Sébastien Villemot, 2019. "The sources of sovereign risk: a calibration based on Lévy stochastic processes," Post-Print hal-05111704, HAL.
    • Handle: RePEc:hal:journl:hal-05111704
    DOI: 10.1016/j.jinteco.2019.02.003
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    Cited by:

    1. Perazzi, Elena, 2020. "Sovereign Bailouts and Moral Hazard with Strategic Default," MPRA Paper 101949, University Library of Munich, Germany.

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    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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