Sovereign Debt as a Contingent Claim: A Quantitative Approach

30 Pages Posted: 5 Apr 2004

See all articles by Laura Alfaro

Laura Alfaro

Harvard University

Fabio Kanczuk

University of São Paulo (USP) - Department of Economics

Abstract

We construct a dynamic equilibrium model with contingent service and adverse selection to quantitatively study sovereign debt. In the model, benefits of defaulting are tempered by higher future interest rates. For a wide set of parameters, the only equilibrium is one in which the sovereign defaults in all states; additional output losses, however, sustain equilibria that resemble the data. We show that due to the adverse selection problem, some countries choose to delay default to reduce loss of reputation. Moreover, although equilibria with no default imply greater welfare levels, they are not sustainable in highly indebted and volatile countries.

Keywords: Sovereign debt, default, contingent claims, sustainability, volatility

JEL Classification: F340, H630

Suggested Citation

Alfaro, Laura and Kanczuk, Fabio, Sovereign Debt as a Contingent Claim: A Quantitative Approach. Journal of International Economics, Forthcoming, Available at SSRN: https://ssrn.com/abstract=524902

Laura Alfaro (Contact Author)

Harvard University ( email )

Cambridge, MA 02138
United States

Fabio Kanczuk

University of São Paulo (USP) - Department of Economics ( email )

Av. Prof. Luciano Gualberto 908
Sao Paulo SP, 05508-900
Brazil
011-55-11-818-5915 (Phone)
011-55-11-3661-7333 (Fax)

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