Sovereign debt dynamics with serial defaults

Abstract

This paper introduces serial defaults in the structural model of Jeanneret (2015. Journal of Financial and Quantitative Analysis 50, 963-985). We consider a government that can default multiple times, deciding endogenously the default thresholds and the optimal leverage. Under the extended model, the sovereign credit spreads are higher and carry a positive serial default premium. Model calibration to eight serial defaulting countries suggests that the average market-implied serial default premium is 57.98 basis points and accounts for 16.07% of the total credit spread. The countries with the highest exposure to serial defaults are Argentina, Brazil, Egypt, and Turkey.

Keywords: Sovereign debt, Structural model, Serial defaults, Stock market

JEL Classification: F34, G12, G13