Sovereign Debt and Reserves with Liquidity and Productivity Crises

53 Pages Posted: 19 Aug 2015

See all articles by Flavia Corneli

Flavia Corneli

Bank of Italy

Emanuele Tarantino

University of Mannheim - Department of Economics; Tilburg Law and Economics Center (TILEC)

Date Written: June 25, 2015

Abstract

During the recent financial crisis developing countries have continued to accumulate both sovereign reserves and debt. To account for this empirical fact, we model the optimal portfolio choice of a country that is subject to liquidity and productivity shocks. We determine the equilibrium level of debt and its cost through a contracting game between a country and international lenders. Although raising debt increases the sovereign exposure to liquidity and productivity crises, the simultaneous accumulation of reserves can mitigate the negative effects of such crises. This mechanism rationalizes the complementarity between debt and reserves.

Keywords: sovereign debt, international reserves, liquidity shock, productivity shock, strategic default

JEL Classification: F34, F40, G15, H63

Suggested Citation

Corneli, Flavia and Tarantino, Emanuele, Sovereign Debt and Reserves with Liquidity and Productivity Crises (June 25, 2015). Bank of Italy Temi di Discussione (Working Paper) No. 1012. Available at SSRN: https://ssrn.com/abstract=2645715 or http://dx.doi.org/10.2139/ssrn.2645715

Flavia Corneli (Contact Author)

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

Emanuele Tarantino

University of Mannheim - Department of Economics ( email )

D-68131 Mannheim
Germany

Tilburg Law and Economics Center (TILEC) ( email )

Warandelaan 2
Tilburg, 5000 LE
Netherlands

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