Endogenous Political Turnover and Fluctuations in Sovereign Default Risk
41 Pages Posted: 11 Jan 2017
Date Written: 2017-01-10
A sovereign default model in which the sovereign derives private benefits from public office and contests elections to stay in power is developed. The economy’s growth process is modeled as a Markov switching regime, which is shown to be a better description of the data for our set of emerging economies. In the model, consistent with evidence, the sovereign is less likely to be reelected if economic growth is weak. In the low-growth regime, there is higher probability of loss of private benefits due to turnover, which makes the sovereign behave more myopically. This growth-linked variation in effective discount factor is shown to be important in generating volatility in sovereign spreads.
Keywords: growth regimes, elections, sovereign default risk
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