Quantitative properties of sovereign default models: solution methods

Juan Carlos Hatchondo, Leonardo Martinez and Horacio Sapriza

Review of Economic Dynamics, 2010, vol. 13, issue 4, pages 919-933

Abstract: 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 technique is more severe for parameterizations that feature a high sensitivity of the bond price to the borrowing level for the borrowing levels that are observed more frequently in the simulations. In addition, we find that the efficiency of the discrete state space technique can be greatly improved by (i) finding the equilibrium as the limit of the equilibrium of the finite-horizon version of the model, instead of iterating separately on the value and bond price functions and (ii) concentrating grid points in asset levels at which the bond price is more sensitive to the borrowing level and in levels that are observed more often in the model simulations. Our analysis is also relevant for the study of other credit markets. (Copyright: Elsevier)

Keywords: Emerging economies; Sovereign debt; Default; Numerical methods (search for similar items in EconPapers)
JEL-codes: F34 F41 (search for similar items in EconPapers)
Date: 2010
References: Add references at CitEc
Citations View citations in EconPapers (13) Track citations by RSS feed

Downloads: (external link)
http://dx.doi.org/10.1016/j.red.2010.03.001
Access to full texts is restricted to ScienceDirect subscribers and institutional members. See http://www.sciencedirect.com/ for details.

Related works:
Software Item: Code and data files for "Quantitative properties of sovereign default models: solution methods matter" (2010)
Working Paper: Technical Appendix to "Quantitative properties of sovereign default models: solution methods" (2010)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: http://EconPapers.repec.org/RePEc:red:issued:08-133

Ordering information: This journal article can be ordered from
http://www.EconomicDynamics.org/RED17.htm

Access Statistics for this article

Review of Economic Dynamics is edited by Gianluca Violante

More articles in Review of Economic Dynamics from Elsevier for the Society for Economic Dynamics
Address: Review of Economic Dynamics Academic Press Editorial Office 525 "B" Street, Suite 1900 San Diego, CA 92101
Contact information at EDIRC.
Series data maintained by Christian Zimmermann ().