Default and Interest Rate Shocks: Renegotiation Matters

Victor Leão Borges de Almeida, Carlos Esquivel, Timothy Kehoe and Juan Pablo Nicolini

No 34555, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We develop a sovereign default model with debt renegotiation in which interest-rate shocks affect default incentives through two mechanisms. Under the standard mechanism, higher interest rates tighten the government’s budget constraint. Under the renegotiation mechanism, higher rates increase lenders’ opportunity cost of holding delinquent debt, which makes lenders accept larger haircuts and makes default more attractive for the government. We argue that our novel renegotiation mechanism reconciles standard sovereign default models with the narrative that the sharp increase in the real interest rate in the United States was a relevant factor in the defaults of the early 1980s.

JEL-codes: F34 F41 G28 (search for similar items in EconPapers)
Date: 2025-12
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Related works:
Working Paper: Default and Interest Rate Shocks: Renegotiation Matters (2024)
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