Sovereign Debt Contract and Optimal Consumption-Investment Strategies

Andriy Demchuk,
Additional contact information
Andriy Demchuk,: HEC-University of Lausanne and FAME

FAME Research Paper Series from International Center for Financial Asset Management and Engineering

Abstract: We present a model in which a sovereign country optimally decides on its consumption and investment policies as well as on the optimal time to default. In the paper we allow the sovereign borrower to keep the fraction of its augmented wealth in so-called international reserves. We further assume that these reserves can be deposited at the risk-free rate. In this framework, we obtain analytical solutions for optimal consumption and investment rules, as well as formulas for optimal default boundary and the value of the risky loan. In the paper we assume that in the case of default the lender can impose economic and political sanctions against the borrower and also can seize an implicit collateral. We show that when the country is getting very close to its default wealth level, then its relative risk aversion decreases and the country increases its consumption rate and the risky investment fraction at the expense of available liquid reserves.

Keywords: sovereign debt; international reserves; strategic default (search for similar items in EconPapers)
JEL-codes: C61 G11 G13 (search for similar items in EconPapers)
Date: 2003-02
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://www.swissfinanceinstitute.ch/rp104.pdf (application/pdf)
Our link check indicates that this URL is bad, the error code is: 404 Not Found (http://www.swissfinanceinstitute.ch/rp104.pdf [301 Moved Permanently]--> https://www.sfi.ch/rp104.pdf [302 Found]--> https://www.sfi.ch/en/rp104.pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fam:rpseri:rp104

Access Statistics for this paper

More papers in FAME Research Paper Series from International Center for Financial Asset Management and Engineering Contact information at EDIRC.
Bibliographic data for series maintained by Ridima Mittal ().