Sovereign default risk and uncertainty premia

Demian Pouzo and Ignacio Presno
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Ignacio Presno: https://www.federalreserve.gov/econres/ignacio-presno.htm

No 12-11, Working Papers from Federal Reserve Bank of Boston

Abstract: This paper studies how foreign investors' concerns about model misspecification affect sovereign bond spreads. We develop a general equilibrium model of sovereign debt with endogenous default wherein investors fear that the probability model of the underlying state of the borrowing economy is misspecified. Consequently, investors demand higher returns on their bond holdings to compensate for the default risk in the context of uncertainty. In contrast with the existing literature on sovereign default, we explain the bond spreads dynamics observed in the data as well as other business cycle features for Argentina, while preserving the default frequency at historical low levels.

Keywords: Bonds; Debts, External (search for similar items in EconPapers)
Date: 2012
New Economics Papers: this item is included in nep-dge, nep-opm and nep-upt
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