Sovereign Risk in International Bond Markets and Nonconvergence

Volker Böhm and George Vachadze

DEGIT Conference Papers from DEGIT, Dynamics, Economic Growth, and International Trade

Abstract: The paper analyzes the consequences of joining markets of government discount bonds between identical economies when, in each country, there exists a positive probability of the government to default. In autarky such economies of overlapping generations of consumers with capital accumulation converge to a unique positive steady state under certain conditions. When two identical economies of this type open their markets for bonds to the consumers of the other country, diversification in portfolio demand by consumers leads to the existence of a world equilibrium with a uniform bond price in every period. Under such circumstances a symmetric stationary world equilibrium with lower risk per country exists, supported by the same level of capital and income as under autarky. However, due to the interaction of dynamic spill over effects between the bond market and the domestic markets for capital investment, the symmetric steady state may become unstable and stable asymmetric steady states appear, implying symmetry breaking in the sense of Matsuyama (2004). The paper identifies a set of assumptions on consumer and production characteristics together with a range of values of the government’s default parameters, such that instability occurs and asymmetric steady states become locally stable.

Keywords: capital accumulation; sovereign risk; international bond markets; non convergence; symmetry-breaking (search for similar items in EconPapers)
JEL-codes: C62 D91 E20 E44 F36 F41 F43 G11 G12 G15 O11 O41 (search for similar items in EconPapers)
Pages: 19 pages
Date: 2009-06
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