Heterogeneous Borrowers in Quantitative Models of Sovereign Default*

Abstract

We extend the model used in recent quantitative studies of sovereign default, allowing policymakers of different types to stochastically alternate in power. We show that a default episode may be triggered by a change in the type of policymaker in office, and that such a default is likely to occur only if there is enough political stability and if policymakers encounter poor economic conditions. Under high political stability, political turnover enables the model to generate a weaker correlation between economic conditions and default decisions, a higher and more volatile spread, and lower borrowing levels after a default episode. Copyright � (2009) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Sovereign default and debt renegotiation

“…The delays in sovereign debt renegotiations after 1990 are on average a little over 2 years in these authors' sample. 30 Other quantitative studies of Eaton-Gersovitz type models without bargaining are Bai and Zhang (2008), Lizarazo (2006), and Hatchondo, Martinez and Sapriza (2007). These papers include risk averse investors, production, and heterogeneous borrowers, respectively.…”

“…4 Chatterjee, Corbae, Nakajima and Rios-Rull (2006) analyze the unsecured consumer credit using a similar framework, and they account for the consumer bankruptcy in the U.S. Other quantitative studies of sovereign debt include Lizarazo (2006), Cuadra and Sapriza (2006), Hatchondo, Martinez and Sapriza (2007), and Mendoza and Yue (2009). 5 Fernandez and Rosenthal (1990) analyze debt renegotiation through which the borrowing country gains improved future access to capital markets.…”

Calibrating the Cost of Defaulting in Models of Sovereign Defaults

“…The representative investor's coefficient of risk aversion is set at 2, and the criteria to choose this parameter is to generate a mean spread for model that is as close as possible to the mean spread in Argentina for the period of study, which corresponds to 12.67%. 19 The representative investor receives a deterministic income of X = 1% of the emerging economy's mean income in each period. As in Lizarazo (2012), this parameter is included to preclude the investors from not investing in the emerging economy in order to avoid a negative consumption level in the case of default.…”

“…For comparison purposes, the risk neutral model has the same number of endowment shocks and the same economies' asset position as the contagion model. 21 19 Lizarazo(2012) also considers a value of 5 for γ L which helps to attain a better match for the level of the spreads and their volatility, however this larger value for γ L has important costs in terms of the computational time that it takes to solve the model. Therefore, given the larger dimension of the contagion model relative to model in Lizarazo(2012), the value of 2 is chosen for γ L .…”

Distributional Incentives in an Equilibrium Model of Domestic Sovereign Default

“…Amador (2003), Dixit and Londregan (2000), D'Erasmo (2011), Guembel and Sussman (2009), Hatchondo, Martinez, andSapriza (2009) andTabellini (1991)). A few studies like those of Alesina and Tabellini (1990) and Aghion and Bolton (1990) do focus on political economy aspects of government debt in a closed economy, including default, and Aguiar, Amador, Farhi, and Gopinath (2013) examine optimal policy in a monetary union subject to self-fulfilling debt crises.…”