Sovereign debt and incentives to default with uninsurable risks

Bloise, G., Polemarchakis, H. and Vailakis, Y. (2017) Sovereign debt and incentives to default with uninsurable risks. Theoretical Economics, 12(3), pp. 1121-1154. (doi:10.3982/TE2146)

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Abstract

We show that sovereign debt is unsustainable if debt contracts are not supported by direct sanctions and default carries only a ban from ever borrowing in financial markets even in the presence of uninsurable risks and time-varying interest rate. This extension of Bulow and Rogoff (1989) requires that the present value of the endowment be finite under the most optimistic valuation. We provide examples where this condition fails and sovereign debt is sustained by the threat of loss of insurance opportunities upon default, despite the fact that the most pessimistic valuation of the endowment, the natural debt limit, is finite.

Item Type:Articles
Status:Published
Refereed:Yes
Glasgow Author(s) Enlighten ID:Vailakis, Professor Yiannis
Authors: Bloise, G., Polemarchakis, H., and Vailakis, Y.
College/School:College of Social Sciences > Adam Smith Business School > Economics
Journal Name:Theoretical Economics
Publisher:Econometric Society
ISSN:1933-6837
ISSN (Online):1555-7561
Published Online:22 September 2017
Copyright Holders:Copyright © 2017 The Authors. Theoretical Economics. The Econometric Society
First Published:First published in Theoretical Economics 12(3): 1121-1154
Publisher Policy:Reproduced under a Creative Commons license

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