Sovereign Debt Issuance and Selective Default

Wojtek Paczos and Kirill Shakhnov

No E2024/6, Cardiff Economics Working Papers from Cardiff University, Cardiff Business School, Economics Section

Abstract: Sovereigns issue debt on both domestic and foreign markets and the two debts are uncorrelated in the data. Sovereigns default mostly selectively. We propose a theory to rationalize these observations. A government chooses the optimal combination of two debts to smooth consumption, which is subject to output shock and volatile tax distortions. In equilibrium, it mostly relies on domestic debt to smooth the tax wedge and on foreign debt to smooth the output shock. Issuing either debt is less costly than raising taxes, but it is subject to default risk due to the government’s limited commitment. A quantitative, calibrated model with two shocks and two debts replicates well debt-to-GDP ratios, default frequencies, cyclical properties of emerging economies and behavior of aggregates around default episodes.

Keywords: sovereign debt; selective default; debt composition (search for similar items in EconPapers)
JEL-codes: F34 G15 H63 (search for similar items in EconPapers)
Pages: 45 pages
Date: 2024-02
New Economics Papers: this item is included in nep-dge, nep-fdg, nep-opm and nep-pbe
References: View references in EconPapers View complete reference list from CitEc
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http://carbsecon.com/wp/E2024_6.pdf (application/pdf)

Related works:
Working Paper: Sovereign Debt Issuance and Selective Default (2016)
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