Escape Routes from Sovereign Default Risk in the Euro Area

29 Pages Posted: 17 Apr 2015

See all articles by Willi Semmler

Willi Semmler

The New School - Department of Economics; Universitaet Bielefeld; IIASA

Christian R. Proaño

The New School for Social Research

Date Written: February 19, 2015

Abstract

The recent financial and sovereign debt crises around the world have sparked a growing literature on models and empirical estimates of defaultable debt. Frequently households and firms come under default threat, local governments can default, and recently sovereign default threats were eminent for Greece and Spain 2012-13. Moreover, Argentina experienced an actual default in 2001. What causes sovereign default risk, and what are the escape routes from default risk? Previous studies such as Arellano (2008), Roch and Uhlig (2013) and Arellano et al. (2014) have provided theoretical models to explore the main dynamics of sovereign defaults. These models can be characterized as threshold models in which there is a convergence toward a good no-default equilibrium below the threshold and a default equilibrium above the threshold. However, in these models aggregate output is exogenous, so that important macroeconomic feedback effects are not taken into account. In this paper, we 1) propose alternative model variants suitable for certain types of countries in the EU where aggregate output is endogenously determined and where financial stress plays a key role, 2) show how these model variants can be solved through the Nonlinear Model Predictive Control numerical technique, and 3) present some empirical evidence on the nonlinear dynamics of output, sovereign debt and financial stress in some euro area and other industrialized countries.

Keywords: Sovereign default risk, financial stress, macroeconomic dynamics, euro crisis

JEL Classification: E44, E62, H63

Suggested Citation

Semmler, Willi and Proaño, Christian R., Escape Routes from Sovereign Default Risk in the Euro Area (February 19, 2015). ZEW - Centre for European Economic Research Discussion Paper No. 15-020. Available at SSRN: https://ssrn.com/abstract=2595078 or http://dx.doi.org/10.2139/ssrn.2595078

Willi Semmler (Contact Author)

The New School - Department of Economics ( email )

65 Fifth Avenue
New York, NY 10003
United States

HOME PAGE: http://www.newschool.edu/nssr/faculty/?id=4e54-6b79-4e41-3d3d

Universitaet Bielefeld ( email )

Universitätsstraße 25
Bielefeld, NRW
Germany

IIASA ( email )

Schlossplatz 1
Laxenburg/Austria, A-2361
Austria

Christian R. Proaño

The New School for Social Research ( email )

6 East 16th Street
New York, NY 10003
United States

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