The sources of sovereign risk: a calibration based on Lévy stochastic processes

Sylvain Carré (), Daniel Cohen and Sébastien Villemot
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Sylvain Carré: Swiss Finance Institute [Geneva] - Swiss Finance Institute, EPFL - Ecole Polytechnique Fédérale de Lausanne

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Abstract: Governments choose to issue risky or riskless debt depending on the nature of the stochastic process of output. We use Brownian motion and Poisson shocks—a modeling method in the literature on corporate default known as Lévy processes—to approximate a decomposition of the output process into a smooth and a jump component. Using an Eaton and Gersovitz (1981) model of debt repudiation, we show that the Brownian part explains the counter-cyclical behavior of the current account, and the Poisson part explains the risk of default—thus enabling our model to account for key stylized facts regarding sovereign risk.

Keywords: Sovereign debt; Default (search for similar items in EconPapers)
Date: 2019-05
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Published in Journal of International Economics, 2019, 118, pp.31-43. ⟨10.1016/j.jinteco.2019.02.003⟩

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Journal Article: The sources of sovereign risk: a calibration based on Lévy stochastic processes (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-05111704

DOI: 10.1016/j.jinteco.2019.02.003

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