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Interest Rate Uncertainty and Sovereign Default Risk

Alok Johri (), Shahed Khan () and Cesar Sosa-Padilla ()

Department of Economics Working Papers from McMaster University

Abstract: Fluctuations in sovereign bond yields display a large global component which is associated with a rise in uncertainty. We build a model of sovereign default in which shocks to the level and to the volatility of the world interest rate help to account for this phenomenon. We calibrate the model parameters to Argentine data and estimate a process for the world interest rate using US treasuries data. Time variation in the world interest rate interacts with default incentives and its effect on borrowing and sovereign spreads is state contingent. We find that shocks to the level and volatility of the world interest rate (i.e. uncertainty shocks) cause the model to predict an average sovereign spread that is 280 basis points larger and 200 basis points more volatile than a model with a constant world interest rate. The model also predicts that countries will prefer a longer maturity for their debt when facing a time-varying world interest rate. The welfare gains from eliminating uncertainty about the world interest rate amount up to a permanent increase in consumption of 1 percent.

Keywords: Sovereign default; Interest rate spread; Political turnover; Left-wing; Right-wing; Cyclicality of fiscal policy. (search for similar items in EconPapers)
JEL-codes: E32 E43 F34 F41 (search for similar items in EconPapers)
Pages: 35 pages
Date: 2018-12
New Economics Papers: this item is included in nep-dge, nep-mac and nep-opm
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Downloads: (external link)
http://socialsciences.mcmaster.ca/econ/rsrch/papers/archive/2018-17.pdf (application/pdf)

Related works:
Working Paper: Interest Rate Uncertainty and Sovereign Default Risk (2020) Downloads
Working Paper: Interest Rate Uncertainty and Sovereign Default Risk (2020) Downloads
Working Paper: Interest Rate Uncertainty and Sovereign Default Risk (2020) Downloads
Working Paper: Interest Rate Uncertainty and Sovereign Default Risk (2017) Downloads
Working Paper: Interest Rate Uncertainty and Sovereign Default Risk (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:mcm:deptwp:2018-17

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