Serial Default and Debt Renegotiation
44 Pages Posted: 27 Mar 2014
Date Written: April 2, 2012
Emerging countries that have defaulted on their debt repayment obligations in the past are more likely to default again in the future than are non-defaulters even with the same debt-to-GDP ratio. This paper explains this stylized fact within a dynamic stochastic general equilibrium framework by explicitly modeling renegotiations between a defaulting country and its creditors. The quantitative analysis of the model reveals that the equilibrium probability of default for a given debt-to-GDP level is weakly increasing with the number of past defaults, consistent with empirical observations. The equilibrium of the model also accords with an additional observed fact: a country for which default terms require less than a 100 percent recovery rate tends to pay a higher rate of return (relative to a risk-free rate) on subsequently issued debt than do defaulting countries that agree to a full recovery rate.
Keywords: Serial default; Debt renegotiation; Past credit history; Recovery rates; Interest
JEL Classification: E43; F32; F34; G12
Suggested Citation: Suggested Citation