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Debt dilution, overborrowing, and sovereign default risk

Listed author(s):
  • Juan Carlos Hatchondo

    (Federal Reserve Bank of Richmond)

  • Cesar Sosa-Padilla

    (University of Maryland)

  • Leonardo Martinez

    (IMF)

We propose a sovereign default framework that allows us to quantify the importance of the debt dilution problem in accounting for overborrowing and sovereign default risk. We find that debt dilution accounts for 12% of the mean debt level and almost 100% of the sovereign default risk in the simulations of a baseline model. Even without commitment to future repayment policies and without contingency of sovereign debt, if the sovereign could eliminate the dilution problem, the number of default per 100 years in our simulations decreases from 2.72 with debt dilution to 0.01 without debt dilution. Our analysis is also relevant for the study of other credit markets where the debt dilution problem could appear.

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File URL: https://economicdynamics.org/meetpapers/2010/paper_481.pdf
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Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 481.

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Date of creation: 2010
Handle: RePEc:red:sed010:481
Contact details of provider: Postal:
Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

Web page: http://www.EconomicDynamics.org/
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  1. Lizarazo, Sandra, 2009. "Contagion of Financial Crises in Sovereign Debt Markets," MPRA Paper 20795, University Library of Munich, Germany, revised 06 Feb 2010.
  2. Niepelt, Dirk, 2014. "Debt maturity without commitment," Journal of Monetary Economics, Elsevier, vol. 68(S), pages 37-54.
  3. Adrien Verdelhan & Nicola Borri, 2010. "Sovereign Risk Premia," 2010 Meeting Papers 1122, Society for Economic Dynamics.
  4. Cristina Arellano & Ananth Ramanarayanan, 2012. "Default and the Maturity Structure in Sovereign Bonds," Journal of Political Economy, University of Chicago Press, vol. 120(2), pages 187-232.
  5. Oren Sussman & Alexander Guembel, 2005. "Sovereign Debt Without Default Penalties," OFRC Working Papers Series 2005fe17, Oxford Financial Research Centre.
  6. Satyajit Chatterjee & Burcu Eyigungor, 2012. "Maturity, Indebtedness, and Default Risk," American Economic Review, American Economic Association, vol. 102(6), pages 2674-2699, October.
  7. Emine Boz & Christian Daude & Ceyhun Bora Durdu, 2008. "Emerging market business cycles revisited: learning about the trend," International Finance Discussion Papers 927, Board of Governors of the Federal Reserve System (U.S.).
  8. Durdu, Ceyhun Bora, 2009. "Quantitative implications of indexed bonds in small open economies," Journal of Economic Dynamics and Control, Elsevier, vol. 33(4), pages 883-902, April.
  9. Horacio Sapriza & Filippo Taddei & Guido Sandleris, 2008. "Indexed Sovereign Debt: An Applied Framework," 2008 Meeting Papers 1064, Society for Economic Dynamics.
  10. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
  11. Juan Jose Cruces & Marcos Buscaglia & Joaquin Alonso, 2002. "The Term Structure of Country Risk and Valuation in Emerging Markets," Working Papers 46, Universidad de San Andres, Departamento de Economia, revised Apr 2002.
  12. Kletzer, Kenneth M, 1984. "Asymmetries of Information and LDC Borrowing with Sovereign Risk," Economic Journal, Royal Economic Society, vol. 94(374), pages 287-307, June.
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