Sovereign Risk and Secondary Markets

Fernando Broner, Alberto Martin and Jaume Ventura ()

No 565, 2006 Meeting Papers from Society for Economic Dynamics

Abstract: The present paper shows that secondary markets can ameliorate, and sometimes fully solve, problems of sovereign risk in international financial markets. We study two environments. In the first one, private agents can in principle issue a complete set of state-contingent securities but governments cannot commit to make payments or enforce payments by their residents. In the second environment, we introduce an additional friction in that only non-contingent securities can be issued. In the absence of secondary markets, in both cases international risk sharing is impossible since countries never make payments to foreigners ex-post. When we introduce secondary markets by allowing agents to trade securities before governments decide whether to make or enforce payments international risk sharing becomes possible. In the first case, secondary markets lead to the first best. In the second case, secondary markets combined with appropriate public debt policy allow for international risk sharing. The mechanism behind our results is that secondary markets tend to transfer securities from those agents who are less likely to be repaid to those agents who are more likely to be repaid. In particular, agents tend to purchase securities issued by other domestic agents and by the domestic government from foreigners. This role of secondary markets in improving enforcement ex-post seems robust and is likely to apply to other environments

Keywords: risk sharing; sovereign risk; secondary markets; sovereign debt (search for similar items in EconPapers)
JEL-codes: F34 F36 G15 (search for similar items in EconPapers)
Date: 2006-12-03
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Related works:
Working Paper: Sovereign Risk and Secondary Markets (2006)
Working Paper: Sovereign Risk and Secondary Markets (2007)
Working Paper: Sovereign Risk and Secondary Markets (2009)
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Persistent link: http://EconPapers.repec.org/RePEc:red:sed006:565

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