Country Default Risk: An Empirical Assessment

36 Pages Posted: 18 Jun 2001  

Jerome L. Stein

Brown University - Division of Applied Mathematics; CESifo (Center for Economic Studies and Ifo Institute)

Giovanna Paladino

IntesaSanpaolo; LUISS Economics Department

Date Written: April 2001

Abstract

We provide benchmarks to evaluate what is an optimal foreign debt and a maximal foreign debt (debt-max), when risk is explicitly considered. When the actual debt exceeds debt-max, then the economy will default when a "bad shock" occurs. This paper is an application of the stochastic optimal controls models of Fleming and Stein (2001), which gives empirical content to the question of how one should measure "vulnerability" to shocks, when there is uncertainty concerning the productivity of capital. We consider two sets of high-risk countries during the period 1978-99: a subset of 21 countries that defaulted on the debt, and another set of 13 countries that did not default. Default is a situation where the firms or government of a country reschedule the interest/principal payments on the external debt. We thereby explain how our analysis can anticipate default risk, and add another dimension to the literature of early warning signals of default/credit risk.

Keywords: Default Risk, Foreign Debt, Stochastic Optimal Control, Debt Rescheduling, Uncertainty

JEL Classification: C61, F34

Suggested Citation

Stein, Jerome L. and Paladino, Giovanna, Country Default Risk: An Empirical Assessment (April 2001). CESifo Working Paper Series No. 469. Available at SSRN: https://ssrn.com/abstract=271550

Jerome L. Stein (Contact Author)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Brown University - Division of Applied Mathematics ( email )

Providence, RI 02912
United States
401-863-2143 (Phone)
401-863-1355 (Fax)

Giovanna Paladino

IntesaSanpaolo ( email )

Piazza San Carlo
Torino, 10121
Italy

LUISS Economics Department ( email )

Viale di Villa Massimo, 57
Rome, 00161
Italy

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