IDEAS home Printed from https://ideas.repec.org/p/imf/imfwpa/10-100.html
   My bibliography  Save this paper

Quantitative properties of sovereign default models; solution methods matter

Author

Listed:
  • Leonardo Martinez
  • Horacio Sapriza
  • Juan Carlos Hatchondo

Abstract

We study the sovereign default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interest rate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space technique is more severe for parameterizations that feature a high sensitivity of the bond price to the borrowing level for the borrowing levels that are observed more frequently in the simulations. In addition, we find that the efficiency of the discrete state space technique can be greatly improved by (i) finding the equilibrium as the limit of the equilibrium of the finite-horizon version of the model, instead of iterating separately on the value and bond price functions and (ii) concentrating grid points in asset levels at which the bond price is more sensitive to the borrowing level and in levels that are observed more often in the model simulations. Our analysis questions the robustness of results in the sovereign default literature and is also relevant for the study of other credit markets.

Suggested Citation

  • Leonardo Martinez & Horacio Sapriza & Juan Carlos Hatchondo, 2010. "Quantitative properties of sovereign default models; solution methods matter," IMF Working Papers 10/100, International Monetary Fund.
  • Handle: RePEc:imf:imfwpa:10/100
    as

    Download full text from publisher

    File URL: http://www.imf.org/external/pubs/cat/longres.aspx?sk=23766
    Download Restriction: no

    Other versions of this item:

    More about this item

    Keywords

    Default; Sovereign debt; Emerging economies; numerical methods; bond; bond price; computation; statistics; simulation results; International Lending and Debt Problems; Open Economy Macroeconomics;

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:imf:imfwpa:10/100. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Jim Beardow) or (Hassan Zaidi). General contact details of provider: http://edirc.repec.org/data/imfffus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    We have no references for this item. You can help adding them by using this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.