Asymmetric Shocks, Long-term Bonds and Sovereign Default

Junjun Zhu () and Shiyu Xie

MPRA Paper from University Library of Munich, Germany

Abstract: We present a sovereign default model with asymmetric shocks and long-term bonds, and solve the model using discrete state dynamic programming. As result, our model matches the Argentinean economy over period 1993Q1-2001Q4 quite well. We show that our model can match high default frequency, high debt/output ratio and other cyclical features, such as countercyclical interest rate and trade balance in emerging countries. Moreover, with asymmetric shocks we are able to match high sovereign spread level and low spread volatility simultaneously in one model, which is till now not well solved. As another contribution of our paper, we propose a simulation-based approach to approximate transition function of output shocks between finite states, which is an indispensable step in discrete state dynamic programming. Comparing to Tauchen’s method, our approach is very flexible in transforming various econometric models to finite state transition function, so that our approach can be widely used in simulating different kinds of discrete state shocks.

Keywords: Sovereign Default; Asymmetric Shocks; Transition Function; Long-term Bonds (search for similar items in EconPapers)
JEL-codes: E44 F34 (search for similar items in EconPapers)
Date: 2011-01-18
New Economics Papers: this item is included in nep-cmp, nep-dge and nep-fmk
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