Sovereign debt and asymmetric market information

Olga Croitorov

No 538831, Working Papers of Department of Economics, Leuven from KU Leuven, Faculty of Economics and Business (FEB), Department of Economics, Leuven

Abstract: I extend the recent quantitative models of sovereign default by allowing asymmetry in information between the government and foreign lenders. As a result, the model can account for the empirical fact that less transparent governments have higher levels of debt. Introducing information asymmetry emphasizes several mechanisms. First, a more informed government demands less precautionary savings. Second, less informed lenders offer a relatively better price when the probability of a bad outcome is higher. The effects of these channels are amplified when government is financially constrained, and any small change in price may trigger a default and bring the average debt level down considerably. Additionally, introducing asymmetric information allows assessing the consequences of the misalignment of market sentiments and generate business cycle moments closer to the one observed in the data.

Date: 2016-04
Note: paper number DPS 16.04
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Published in Department of Economics. Discussion paper series,, pages 1-36

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Persistent link: https://EconPapers.repec.org/RePEc:ete:ceswps:538831

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