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Sovereign risk and firm heterogeneity
This paper studies the recessionary effects of sovereign default risk using firm-level data and a model of sovereign debt with firm heterogeneity. Our environment features a two-way feedback loop. Low output decreases the tax revenues of the government and raises the risk that it will default on its debt. The associated increase in sovereign interest rate spreads, in turn, raises the interest rates paid by firms, which further depresses their production. Importantly, these effects are not homogeneous across firms, as interest rate hikes have more severe consequences for firms that are in need ...
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Renegotiation Policies in Sovereign Defaults
This paper studies an optimal renegotiation protocol designed by a benevolent planner when two countries renegotiate with the same lender. The solution calls for recoveries that induce each country to default or repay, trading off the deadweight costs and the redistribution benefits of default independently of the other country. This outcome contrasts with a decentralized bargaining solution where default in one country increases the likelihood of default in the second country because recoveries are lower when both countries renegotiate. The paper suggests that policies geared at designing ...
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Partial Default
In the data sovereign default is always partial and varies in its duration. Debt levels during default episodes initially increase and do not experience reductions upon resolution. This paper presents a theory of sovereign default that replicates these properties, which are absent in standard sovereign default theory. Partial default is a flexible way to raise funds as the sovereign chooses its intensity and duration. Partial default is also costly because it amplifies debt crises as the defaulted debt accumulates and interest rate spreads increase. This theory is capable of rationalizing the ...
Working Paper
External and Public Debt Crises
The recent debt crises in Europe and the U.S. states feature similar sharp increases in spreads on government debt but also show important differences. In Europe, the crisis occurred at high government indebtedness levels and had spillovers to the private sector. In the United States, state government indebtedness was low, and the crisis had no spillovers to the private sector. We show theoretically and empirically that these different debt experiences result from the interplay between differences in the ability of governments to interfere in private external debt contracts and differences in ...
Report
Appendix for Financial Frictions and Fluctuations in Volatility
This appendix contains five sections. Section 1 provides details for the comparative statics exercise performed in the simple example. Section 2 discusses extending the model to allow firms to default on the wages for managers. Section 3 describes the firm-level and aggregate data. Section 4 contains the details of the computational algorithm. Finally, Section 5 reports the results for our model with a lower labor elasticity.
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Financial frictions and fluctuations in volatility
During the recent U.S. financial crisis, the large decline in economic activity and credit was accompanied by a large increase in the dispersion of growth rates across firms. However, even though aggregate labor and output fell sharply during this period, labor productivity did not. These features motivate us to build a model in which increased volatility at the firm level generates a downturn but has little effect on labor productivity. In the model, hiring inputs is risky because financial frictions limit firms' ability to insure against shocks that occur between the time of production and ...
Discussion Paper
Chronic sovereign debt crises in the Eurozone, 2010-2012
Two years after the rescue package for Greece provided by the European Union and the International Monetary Fund in May 2010, sovereign debt crises continue to threaten a growing number of countries in the eurozone. We develop a theory for analyzing these crises based on the research of Cole and Kehoe (1996, 2000) and Conesa and Kehoe (2012). In this theory, the need to frequently sell large quantities of bonds leaves a country vulnerable to sovereign debt crisis. This vulnerability provides a strong incentive to the country?s government to run surpluses to pay down its debt to a level where ...
Working Paper
Default and the maturity structure in sovereign bonds
This paper studies the maturity composition and the term structure of interest rate spreads of government debt in emerging markets. We document that in Argentina, Brazil, Mexico, and Russia, when interest rate spreads rise, debt maturity shortens and the spread on short-term bonds is higher than on long-term bonds. To account for this pattern, we build a dynamic model of international borrowing with endogenous default and multiple maturities of debt. Short-term debt can deliver higher immediate consumption than long-term debt; large longterm loans are not available because the borrower cannot ...
Report
Linkages across sovereign debt markets
We develop a multicountry model in which default in one country triggers default in other countries. Countries are linked to one another by borrowing from and renegotiating with common lenders with concave payoffs. A foreign default increases incentives to default at home because it makes new borrowing more expensive and defaulting less costly. Foreign defaults tighten home bond prices because they lower lenders' payoffs. Foreign defaults make home default less costly by lowering future recoveries, because countries can extract more surplus if they renegotiate simultaneously. In our model, ...
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Monetary Policy and Sovereign Risk in Emerging Economies (NK-Default)
This paper develops a New Keynesian model with sovereign default risk (NK-Default). We focus on the interaction between monetary policy, conducted according to an interest rate rule that targets inflation, and external defaultable debt issued by the government. Monetary policy and default risk interact since both affect domestic consumption, production, and inflation. We find that default risk amplifies monetary frictions and generates a tension for monetary policy, which increases the volatility of inflation and nominal rates. These monetary frictions in turn discipline sovereign borrowing, ...