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Decentralized Borrowing and Centralized Default

Yun Jung Kim () and Jing Zhang ()

No 596, Working Papers from Research Seminar in International Economics, University of Michigan

Abstract: In the past, foreign borrowing by developing countries was comprised almost entirely of government borrowing. Recently, private firms and individuals in developing countries borrow substantially from foreign lenders. It is not clear whether the observed increase in private sector borrowing leads to overborrowing and frequent defaults by governments in developing countries. In this paper, we develop a tractable quantitative model in which private agents decide how much to borrow but the government decides whether to default. The model with decentralized borrowing increases aggregate credit costs and sovereign default risk, and reduces aggregate welfare, relative to a model with centralized borrowing. Private agents do not internalize the effect of their borrowing on economy-wide credit costs and thus would like to borrow more than the socially efficient level. Depending on the severity of default penalties, decentralized borrowing may lead to either too much or too little debt in equilibrium. The introduction of decentralized borrowing substantially improves the model's empirical fit in terms of matching observed debt levels and default rates.

Keywords: Sovereign Default; Sovereign Debt; Private Borrowing; Capital Flows (search for similar items in EconPapers)
JEL-codes: F32 F34 F41 (search for similar items in EconPapers)
Pages: 27 pages
Date: 2010-04
New Economics Papers: this item is included in nep-dge
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http://www.fordschool.umich.edu/rsie/workingpapers/Papers576-600/r596.pdf

Related works:
Journal Article: Decentralized borrowing and centralized default (2012) Downloads
Working Paper: Decentralized Borrowing and Centralized Default (2010) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:mie:wpaper:596

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