Optimal Sovereign Debt Default
We determine optimal government default policies for a small open economy in which a domestic government can borrow internationally by issuing non-contingent debt contracts. Unlike earlier work, we consider optimal default policies under full government commitment and treat repayment of international debt as a decision variable. Default can be optimal under commitment because it allows for increased international diversiÃƒÃ‚cation of domestic output and consumption risk when government bond markets are incomplete. In the absence of default costs, default optimally occurs very frequently and independently of the country's net foreign asset position. Optimal default policies, however, change drastically when a government default entails small but positive dead weight costs: default is then optimal only in response to disaster-like shocks to domestic output, or when a small adverse shock pushes international debt levels sufficiently close to the country's borrowing limit. Optimal default policies increase welfare signiÃƒÃ‚cantly compared to a situation where default is ruled out by assumption, even for sizable default costs. For sufficiently low level of default costs the optimal default policies can approximately be replicated by issuing a simple equity-like government bond.
|Date of creation:||2012|
|Date of revision:|
|Contact details of provider:|| Postal: |
Web page: http://www.EconomicDynamics.org/
More information through EDIRC
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Juan J. Cruces & Christoph Trebesch, 2011.
"Sovereign Defaults: The Price of Haircuts,"
CESifo Working Paper Series
3604, CESifo Group Munich.
- Rietz, Thomas A., 1988. "The equity risk premium a solution," Journal of Monetary Economics, Elsevier, vol. 22(1), pages 117-131, July.
- Zame, William R, 1993.
"Efficiency and the Role of Default When Security Markets Are Incomplete,"
American Economic Review,
American Economic Association, vol. 83(5), pages 1142-64, December.
- William R. Zame, 1990. "Efficiency and the Role of Default When Security Markets are Incomplete," UCLA Economics Working Papers 585, UCLA Department of Economics.
- William R. Zame, 1992. "Efficiency and the Role of Default When Security Markets are Incomplete," UCLA Economics Working Papers 673, UCLA Department of Economics.
- Herschel I. Grossman & John B. Van Huyck, 1985.
"Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation,"
NBER Working Papers
1673, National Bureau of Economic Research, Inc.
- Grossman, Herschel I & Van Huyck, John B, 1988. "Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation," American Economic Review, American Economic Association, vol. 78(5), pages 1088-97, December.
- V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991.
"Optimal fiscal and monetary policy: some recent results,"
Federal Reserve Bank of Cleveland, pages 519-546.
- Chari, V V & Christiano, Lawrence J & Kehoe, Patrick J, 1991. "Optimal Fiscal and Monetary Policy: Some Recent Results," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 519-39, August.
- V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991. "Optimal fiscal and monetary policy: some recent results," Staff Report 147, Federal Reserve Bank of Minneapolis.
- Christopher A. Sims, 2001.
"Fiscal consequences for Mexico of adopting the dollar,"
Federal Reserve Bank of Cleveland, pages 597-625.
- Sims, Christopher A, 2001. "Fiscal Consequences for Mexico of Adopting the Dollar," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 33(2), pages 597-616, May.
- Ugo Panizza & Federico Sturzenegger & Jeromin Zettelmeyer, 2009. "The Economics and Law of Sovereign Debt and Default," Journal of Economic Literature, American Economic Association, vol. 47(3), pages 651-98, September.
When requesting a correction, please mention this item's handle: RePEc:red:sed012:882. 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)
If references are entirely missing, you can add them using this form.