Working Paper: CEPR ID: DP8971
Authors: Daniel Cohen; Sébastien Villemot
Abstract: Why do countries default? This seemingly simple question has yet to be adequately answered in the literature. Indeed, prevailing modelling strategies compel the to choose between two unappealing model features: depending on the cost of default selected by the modeler, either the debt ratios are too high and the probability of default is too low or the opposite is true. In view of the historical evidence that countries always default after a crisis, we propose a novel approach to the theory of debt default and develop a model that matches the key stylized facts regarding sovereign risk.
Keywords: Sovereign debt; Levy stochastic processes
JEL Codes: F34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| cost of default (G33) | debt-to-GDP ratios (H68) |
| cost of default (G33) | probability of default (G33) |
| crises (H12) | cost of default (G33) |
| timing of crisis (H12) | perceived costs of default (G33) |
| perceived costs of default (G33) | likelihood of default (G33) |
| crises (H12) | defaults (Y60) |
| cost of default (G33) | debt sustainability (H63) |