Sovereign Default, Domestic Banks and Exclusion from International Capital Markets

Dominik Thaler

The Economic Journal, 2021, vol. 131, issue 635, 1401-1427

Abstract: Why do governments borrow internationally? Why do they temporarily remain out of international financial markets after default? This paper develops a quantitative model of sovereign default to propose a unified answer to these questions. In the model, the government has an incentive to borrow internationally since the domestic return on capital exceeds the world interest rate, due to a friction in the banking sector. Since banks are exposed to sovereign debt, sovereign default causes a financial crisis. After default, the government chooses to reaccess international capital markets only once banks have recovered and efficiently allocate investment again. Exclusion hence arises endogenously.

Date: 2021
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Working Paper: Sovereign default, domestic banks and exclusion from international capital markets (2018)
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