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  • March 2005
  • Article
  • Journal of International Economics

Sovereign Debt As a Contingent Claim: A Quantitative Approach

By: Laura Alfaro and Fabio Kanczuk
  • Format:Print
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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 in greater welfare levels, they are not sustainable in highly indebted and volatile countries.

Keywords

Sovereign Finance; Borrowing And Debt; Interest Rates; Balance And Stability; Risk And Uncertainty; Risk Management; Mathematical Methods; Management Style; Segmentation; Debt Securities; Banking Industry

Citation

Alfaro, Laura, and Fabio Kanczuk. "Sovereign Debt As a Contingent Claim: A Quantitative Approach." Journal of International Economics 65, no. 2 (March 2005).
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About The Author

Laura Alfaro

General Management
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More from the Authors

    • March 2021
    • Journal of Financial Economics

    On the Direct and Indirect Real Effects of Credit Supply Shocks

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    Latam Airlines and COVID-19: Seeking Bankruptcy Protection in the United States

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    • 2020
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    Reserve Accumulation, Sovereign Debt, and Exchange Rate Policy

    By: Laura Alfaro and Fabio Kanczuk
More from the Authors
  • On the Direct and Indirect Real Effects of Credit Supply Shocks By: Laura Alfaro, Manuel García-Santana and Enrique Moral-Benito
  • Latam Airlines and COVID-19: Seeking Bankruptcy Protection in the United States By: Laura Alfaro
  • Reserve Accumulation, Sovereign Debt, and Exchange Rate Policy By: Laura Alfaro and Fabio Kanczuk
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