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Debt dilution, overborrowing, and sovereign default risk

  • 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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Paper provided by Society for Economic Dynamics in its series 2010 Meeting Papers with number 481.

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Date of creation: 2010
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Handle: RePEc:red:sed010:481
Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Web page: http://www.EconomicDynamics.org/society.htm
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  1. Fernando Broner & Guido Lorenzoni & Sergio Schmuckler, 2006. "Why Do Emerging Economies Borrow Short Term?," 2006 Meeting Papers 841, Society for Economic Dynamics.
  2. Cristina Arellano & Ananth Ramanarayanan, 2008. "Default and the maturity structure in sovereign bonds," Staff Report 410, Federal Reserve Bank of Minneapolis.
  3. Hatchondo, Juan Carlos & Martinez, Leonardo, 2009. "Long-duration bonds and sovereign defaults," Journal of International Economics, Elsevier, vol. 79(1), pages 117-125, September.
  4. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2008. "Heterogeneous borrowers in quantitative models of sovereign default," Working Paper 07-01, Federal Reserve Bank of Richmond.
  5. Horacio Sapriza & Filippo Taddei & Guido Sandleris, 2008. "Indexed Sovereign Debt: An Applied Framework," 2008 Meeting Papers 1064, Society for Economic Dynamics.
  6. Martín González-Rozada & EduardoLevy Yeyati, 2008. "Global Factors and Emerging Market Spreads," Economic Journal, Royal Economic Society, vol. 118(533), pages 1917-1936, November.
  7. Juan M. Sanchez & Horacio Sapriza & Gabriel Cuadra, 2009. "Fiscal Policy and Default Risk in Emerging Markets," 2009 Meeting Papers 701, Society for Economic Dynamics.
  8. Yan Bai & Jing Zhang, 2009. "Financial Integration and International Risk Sharing," Working Papers 594, Research Seminar in International Economics, University of Michigan.
  9. Satyajit Chatterjee & Burcu Eyigungor, 2009. "Maturity, Indebtedness, and Default Risk," Koç University-TUSIAD Economic Research Forum Working Papers 0901, Koc University-TUSIAD Economic Research Forum.
  10. Satyajit Chatterjee & Dean Corbae & Makoto Nakajima & Jose-Victor Rios-Rull, 2002. "A Quantitative Theory of Unsecured Consumer Credit with Risk of Default," Centro de Alti­simos Estudios Ri­os Pe©rez(CAERP) 2, Centro de Altisimos Estudios Rios Perez (CAERP).
  11. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
  12. Alfaro, Laura & Kanczuk, Fabio, 2005. "Sovereign debt as a contingent claim: a quantitative approach," Journal of International Economics, Elsevier, vol. 65(2), pages 297-314, March.
  13. Niepelt, Dirk, 2008. "Debt Maturity without Commitment," CEPR Discussion Papers 7093, C.E.P.R. Discussion Papers.
  14. Adrien Verdelhan & Nicola Borri, 2010. "Sovereign Risk Premia," 2010 Meeting Papers 1122, Society for Economic Dynamics.
  15. Sandra Lizarazo, 2009. "Contagion of Financial Crises in Sovereing Debt Markets," Working Papers 0906, Centro de Investigacion Economica, ITAM.
  16. Martín Uribe, 2006. "Individual Versus Aggregate Collateral Constraints and the Overborrowing Syndrome," NBER Working Papers 12260, National Bureau of Economic Research, Inc.
  17. David Benjamin & Mark L. J. Wright, 2009. "Recovery Before Redemption: A Theory Of Delays In Sovereign Debt Renegotiations," CAMA Working Papers 2009-15, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  18. Gabriel Cuadra & Horacio Sapriza, 2006. "Sovereign Default, Interest Rates and Political Uncertainty in Emerging Markets," Working Papers 2006-02, Banco de México.
  19. Michael Tomz & Mark L. J. Wright, 2007. "Do countries default in “bad times”?," Working Paper Series 2007-17, Federal Reserve Bank of San Francisco.
  20. 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.
  21. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2009. "On the cyclicality of the interest rate in emerging economy models: solution methods matter," Working Paper 09-13, Federal Reserve Bank of Richmond.
  22. repec:acb:camaaa:2009-15 is not listed on IDEAS
  23. Oren Sussman & Alexander Guembel, 2005. "Sovereign Debt Without Default Penalties," OFRC Working Papers Series 2005fe17, Oxford Financial Research Centre.
  24. Aguiar, Mark & Gopinath, Gita, 2007. "Emerging Market Business Cycles: The Cycle is the Trend," Scholarly Articles 11988098, Harvard University Department of Economics.
  25. Emine Boz & Christian Daude & C. Bora Durdu, 2011. "Emerging Market Business Cycles Revisited: Learning about the Trend," Koç University-TUSIAD Economic Research Forum Working Papers 1110, Koc University-TUSIAD Economic Research Forum.
  26. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2007. "Quantitative models of sovereign default and the threat of financial exclusion," Economic Quarterly, Federal Reserve Bank of Richmond, issue Sum, pages 251-286.
  27. Juan M. Sanchez, 2008. "The Role of Information in Consumer Debt and Bankruptcy," 2008 Meeting Papers 523, Society for Economic Dynamics.
  28. Gabriel Cuadra & Horacio Sapriza, 2006. "Sovereign Default, Terms of Trade and Interest Rates in Emerging Markets," Working Papers 2006-01, Banco de México.
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