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History Remembered: Optimal Sovereign Default on Domestic and External Debt

Pablo D'Erasmo () and Enrique Mendoza ()

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

Abstract: Infrequent but turbulent overt sovereign defaults on domestic creditors are a "forgotten history" in Macroeconomics. We propose a heterogeneous-agents model in which the government chooses optimal debt and default on domestic and foreign creditors by balancing distributional incentives v. the social value of debt for self-insurance, liquidity, and risk-sharing. A rich feedback mechanism links debt issuance, the distribution of debt holdings, the default decision, and risk premia. Calibrated to Eurozone data, the model is consistent with key long-run and debt-crisis statistics. Defaults are rare (1.2 percent frequency), and preceded by surging debt and spreads. Debt sells at the risk-free price most of the time, but the government's lack of commitment reduces sustainable debt sharply.

Keywords: public debt; sovereign default; debt crisis; European crisis (search for similar items in EconPapers)
JEL-codes: E6 E44 F34 H63 (search for similar items in EconPapers)
Pages: 86 pages
Date: 2018-09-14, Revised 2018-09-14
New Economics Papers: this item is included in nep-dge, nep-mac and nep-opm
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Related works:
Working Paper: History Remembered: Optimal Sovereign Default on Domestic and External Debt (2019) Downloads
Working Paper: History Remembered: Optimal Sovereign Default on Domestic and External Debt (2018) Downloads
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Persistent link: https://EconPapers.repec.org/RePEc:pen:papers:18-018

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