Heterogeneous borrowers in quantitative models of sovereign default

Juan Carlos Hatchondo, Leonardo Martinez and Horacio Sapriza

No 07-01, Working Paper from Federal Reserve Bank of Richmond

Abstract: We extend the model used in recent quantitative studies of sovereign default, allowing policymakers of different types to alternate in power. We show that a default episode may be triggered by a change in the type of policymaker in office, and that such a default is likely to occur only if there is enough political stability and if policymakers encounter poor economic conditions. Under high political stability, political turnover enables the model to generate a weaker correlation between economic conditions and default decisions, a higher and more volatile spread, and lower borrowing levels after a default episode.

Date: 2008
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