Prudent sovereign debt borrowing

Christopher Bliss

Oxford Economic Papers, 2018, vol. 70, issue 4, 1136-1147

Abstract: A sovereign borrower is modelled as a rational calculator choosing levels of investment, consumption, and borrowing to maximize the expected level of a valuation function. The borrowing nation knows that it may opt to default on its debt. The lenders understand this and price their loans to fully compensate for the risk of default. A boundary defines a set of states below which the default option will be exercised. Close to that boundary both consumption and investment are suppressed. The influence of the cost of default is most clear via its effects on the marginal valuations of consumption and investment.

JEL-codes: F34 F41 G01 G15 (search for similar items in EconPapers)
Date: 2018
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