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Distributional Incentives in an Equilibrium Model of Domestic Sovereign Default

  • Pablo D'Erasmo
  • Enrique G. Mendoza

Europe’s debt crisis resembles historical episodes of outright default on domestic public debt about which little research exists. This paper proposes a theory of domestic sovereign default based on distributional incentives affecting the welfare of risk-averse debt- and non-debt holders. A utilitarian government cannot sustain debt if default is costless. If default is costly, debt with default risk is sustainable, and debt falls as concentration of debt ownership rises. A government favoring bond holders can also sustain debt, with debt rising as ownership becomes more concentrated. These results are robust to adding foreign investors, redistributive taxes, or a second asset.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 19477.

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Date of creation: Sep 2013
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Publication status: published as Distributional Incentives in an Equilibrium Model of Domestic Sovereign Default , Pablo D'Erasmo, Enrique G. Mendoza. in Sovereign Debt and Financial Crises , Kalemli-Ozcan, Reinhart, and Rogoff. 2016
Handle: RePEc:nbr:nberwo:19477
Note: IFM ME PE
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