Essays on sovereign debt and default

Abstract

The first chapter studies the effects of government capital accumulation on sovereign debt default risk and debt restructuring renegotiation outcomes when a government has limited ability to extract revenues from households. To do so, this chapter develops a quantitative dynamic stochastic general equilibrium model of sovereign default, debt renegotiation, and fiscal policies, where the government chooses between the fiscal expenditures of government consumption and government investment. Government capital provides an additional means of adjustment in the face of a bad productivity shock. It also affects the government's incentive to re-access the international credit market when the government chooses to default. The model delivers three key predictions: (1) a higher level of government capital implies less risky sovereign debt and higher recovery rates when the government chooses to default; (2) a high debt to output ratio is sustainable with a sufficient level of government capital; (3) fiscal adjustment that reduces public investment may be self-defeating.

The second chapter investigates the empirical facts that government expenditures and taxes are procyclical in developing countries but countercyclical or acyclical in developed economies. This chapter provides a possible explanation for this stylized fact by introducing news about future total factor productivity and endogenous fiscal policy in an otherwise-standard small open economy model of sovereign default risk, as in Arellano (2008). News tends to be more precise in developed countries, which relaxes credit constraints on foreign borrowing and makes developed countries less reliant on tax revenues. This dampens and potentially reverses the high correlation between output and government expenditures/taxes observed in developed countries.

The third chapter studies the impact of creditors' income process on the outcomes of sovereign debt restructurings. This chapter compiles a new dataset on foreign creditors' income process during negotiation. This chapter shows that when foreign creditors are facing high income, restructurings are protracted and result in smaller haircuts. To explain these stylized facts, this chapter develops a dynamic stochastic general equilibrium model of defaultable debt that embeds multi-rounds negotiations between a risk-averse sovereign and risk-averse creditors. The quantitative analysis shows that high creditors' income results in a longer duration of restructuring and higher haircuts.