Search Results
Working Paper
International Reserves and Rollover Risk
We study the optimal accumulation of international reserves in a quantitative model of sovereign default with long-term debt and a risk-free asset. Keeping higher levels of reserves provides a hedge against rollover risk, but this is costly because using reserves to pay down debt allows the government to reduce sovereign spreads. Our model, parameterized to mimic salient features of a typical emerging economy, can account for a significant fraction of the holdings of international reserves, and the larger accumulation of both debt and reserves in periods of low spreads and high income. We ...
Journal Article
On the benefits of GDP-indexed government debt: lessons from a model of sovereign defaults
Whether governments should issue GDP-indexed sovereign debt continues to be the subject of policy debates. This article contributes to this debate by studying the effects of issuing GDP-indexed sovereign debt contracts using the equilibrium default model studied by Aguiar and Gopinath (2006) and Arellano (2008). We consider an extension with perfect indexation, i.e., the government issues Arrow-Debreu securities with payoffs that depend on the next-period aggregate income realization. The ex-ante welfare gain from the introduction of income-indexed bonds is equivalent to a permanent increase ...
Working Paper
Long-duration bonds and sovereign defaults
This paper extends the baseline framework used in recent quantitative studies of sovereign default by assuming that governments can borrow using long-duration bonds. Previous studies have assumed that governments can borrow using bonds that mature after one quarter. Once we assume that the government issues bonds with a duration that is close to the average duration observed in emerging economies, the model is able to generate a substantially higher and more volatile interest rate. This narrows the gap between the predictions of the model and the data, which indicates that the introduction of ...
Working Paper
International reserves and rollover risk
Two striking facts about international capital flows in emerging economies motivate this paper: (1) Governments hold large amounts of international reserves, for which they obtain a return lower than their borrowing cost. (2) Purchases of domestic assets by nonresidents and purchases of foreign assets by residents are both procyclical and collapse during crises. We propose a dynamic model of endogenous default that can account for these facts. The government faces a trade-off between the benefits of keeping reserves as a buffer against rollover risk and the cost of having larger gross debt ...
Working Paper
A theory of political cycles
We study how the proximity of elections affects policy choices in a model in which policymakers want to improve their reputation to increase their reelection chances. Policymakers' equilibrium decisions depend on both their reputation and the proximity of the next election. Typically, incentives to influence election results are stronger closer to the election (for a given reputation level), as argued in the political cycles literature, and these political cycles are less important when the policymaker's reputation is better. Our analysis sheds light on other agency relationships in which ...
Journal Article
Legal protection to foreign investors
Foreign investment is typically considered an important source of growth for developing countries. This article describes the legal protection granted to foreign investors and its enforcement mechanisms. Governments have signed international investment agreements intended to protect foreign investors from the risk of expropriation and have increasingly chosen to issue sovereign debt in international financial centers, which expose defaulting governments to litigations in foreign national courts. In most cases, governments have complied with unfavorable rulings of international arbitration ...
Working Paper
On the cyclicality of the interest rate in emerging economy models: solution methods matter
We study the sovereign default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interest rate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space ...
Working Paper
Debt dilution and sovereign default risk
We measure the effects of debt dilution on sovereign default risk and show how these effects can be mitigated with debt contracts promising borrowing-contingent payments. First, we calibrate a baseline model la Eaton and Gersovitz (1981) to match features of the data. In this model, bonds' values can be diluted. Second, we present a model in which sovereign bonds contain a covenant promising that after each time the government borrows it pays to the holder of each bond issued in previous periods the difference between the bond market price that would have been observed absent current-period ...
Working Paper
Reputation, career concerns, and job assignments
Does a worker who had a successful career have stronger or weaker incentives to manipulate his reputation than a worker who performed poorly? This paper presents a tractable model that allows us to study career concerns when the strength of a worker?s incentives depends on his employment history (the history of his past actions, jobs, and performances). More specifically, the paper incorporates standard job assignments into the main model in Holmstrom?s (1999) seminal paper on career concerns. Equilibrium wages, equilibrium job assignments, and the strength of career-concern incentives are ...