Persistent Gaps and Default Traps

Posted: 16 Jan 2009

See all articles by Luis Catão

Luis Catão

International Monetary Fund (IMF)

Ana Fostel

University of Virginia

Sandeep Kapur

University of London - Birkbeck College; University of London - Economics, Mathematics and Statistics

Date Written: January, 15 2009

Abstract

We show how vicious circles in countries' credit histories arise in a model where output persistence is coupled with asymmetric information about output shocks. In such an environment, default signals the borrower's vulnerability to adverse shocks and creates a pessimistic growth outlook. This translates into higher interest spreads and debt servicing costs relative to income, raising the cost of future repayments, thereby creating default traps. We build a long and broad cross-country dataset to show the existence of a history-dependent default premium and of significant effects of output persistence on sovereign creditworthiness, consistent with the model's predictions.

Keywords: Sovereign Debt, Serial default, Default premium, Emerging market bond spreads, Asymmetric information, Output persistence

JEL Classification: F34, G15, H63, N20

Suggested Citation

Catão, Luis and Fostel, Ana and Kapur, Sandeep, Persistent Gaps and Default Traps (January, 15 2009). Journal of Development Economics, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1328571

Luis Catão

International Monetary Fund (IMF) ( email )

700 19th Street NW
Washington, DC 20431
United States

Ana Fostel (Contact Author)

University of Virginia ( email )

1400 University Ave
Charlottesville, VA 22903
United States

Sandeep Kapur

University of London - Birkbeck College ( email )

Malet Street
London, WC1E 7HX
United Kingdom

University of London - Economics, Mathematics and Statistics ( email )

7-15 Gresse Street
London, WC1E 7HX
United Kingdom
+44 20 7631 6405 (Phone)
+44 20 7631 6416 (Fax)

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