Optimal External Debt and Default

Bernardo Guimaraes

CEP Discussion Papers from Centre for Economic Performance, LSE

Abstract: This paper analyses whether sovereign default episodes can be seen as contingencies of optimal international lending contracts. The model considers a small open economy with capital accumulation and without commitment to repay debt. Taking first order approximations of Bellman equations, I derive analytical expressions for the equilibrium level of debt and the optimal debt contract. In this environment, debt relief generated by reasonable fluctuations in productivity is an order of magnitude below that generated by shocks to world interest rates. Debt relief prescribed by the model following the interest rate hikes of 1980-81 accounts for a substantial part of the debt forgiveness obtained by the main Latin American countries through the Brady agreements.

Keywords: sovereign debt; default; capital flows; optimal contract; world interest rates (search for similar items in EconPapers)
JEL-codes: F3 F4 G1 (search for similar items in EconPapers)
Date: 2008-02
New Economics Papers: this item is included in nep-cba, nep-cfn, nep-dge and nep-opm
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Related works:
Working Paper: Optimal external debt and default (2008)
Working Paper: Optimal external debt and default (2007)
Working Paper: Optimal external debt and default (2007)
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Persistent link: https://EconPapers.repec.org/RePEc:cep:cepdps:dp0847

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