IDEAS home Printed from https://ideas.repec.org/p/red/sed006/299.html
   My bibliography  Save this paper

Default and the Term Structure in Sovereign Bonds

Author

Listed:
  • Cristina Arellano

    () (Department of Economics University of Minnesota)

  • Ananth Ramanarayanan

Abstract

This paper builds a dynamic model of borrowing and default to study the term structure of sovereign bonds in emerging markets. The borrower in the model can buy short and long bonds at contingent prices that reflect the timing of default events. The model generates a yield curve that is upward sloping on tranquil times as in the data. The reason is that if default events are likely in the future but not in the near term, only the long yield will be adjusted for this. However if default is a likely event in the near future the yield curve is inverted. In this case, long bonds are safer than short bonds for lenders in present value terms, because if the economy avoids the stressed period, it may repay its debt obligations in all future states. This matches the data in emerging markets bonds where in times of crises yields of shorter bonds are higher. The model also delivers that long bonds are issued primarily on tranquil times and short debt is used more heavily during crisis as in emerging markets. In the model long debt provides a good hedge against future bad shocks because the effective cost for such borrowing is lower exactly in times of high interest rates. Thus the borrower prefers in tranquil times long bonds because of the additional benefits. In addition, this effect increases borrowing incentives which in equilibrium translates into higher default probabilities. We calibrate the model to Brazil and find that the model can match various features of the data including the volatility of long and short bonds yields.

Suggested Citation

  • Cristina Arellano & Ananth Ramanarayanan, 2006. "Default and the Term Structure in Sovereign Bonds," 2006 Meeting Papers 299, Society for Economic Dynamics.
  • Handle: RePEc:red:sed006:299
    as

    Download full text from publisher

    To our knowledge, this item is not available for download. To find whether it is available, there are three options:
    1. Check below whether another version of this item is available online.
    2. Check on the provider's web page whether it is in fact available.
    3. Perform a search for a similarly titled item that would be available.

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Laura Alfaro & Fabio Kanczuk, 2009. "Debt Maturity: Is Long-Term Debt Optimal?," Review of International Economics, Wiley Blackwell, vol. 17(5), pages 890-905, November.
    2. Leonardo Martinez & Juan Carlos Hatchondo, 2008. "A model of credit risk without commitment," 2008 Meeting Papers 940, Society for Economic Dynamics.
    3. Richard H. Clarida & Ildikó Magyari, 2016. "International Financial Adjustment in a Canonical Open Economy Growth Model," NBER Working Papers 22758, National Bureau of Economic Research, Inc.
    4. Ran Bi, 2008. ""Beneficial" Delays in Debt Restructuring Negotiations," 2008 Meeting Papers 766, Society for Economic Dynamics.
    5. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2009. "Heterogeneous Borrowers In Quantitative Models Of Sovereign Default," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 50(4), pages 1129-1151, November.

    More about this item

    Keywords

    Sovereign Debt; Default; Term Structure;

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F31 - International Economics - - International Finance - - - Foreign Exchange

    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:red:sed006:299. 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: (Christian Zimmermann). General contact details of provider: http://edirc.repec.org/data/sedddea.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.