Working Paper: NBER ID: w24981
Authors: Luigi Bocola; Gideon Bornstein; Alessandro Dovis
Abstract: A large literature has developed quantitative versions of the Eaton and Gersovitz (1981) model to analyze default episodes on external debt. In this paper, we study whether the same framework can be applied to the analysis of debt crises in which domestic public debt plays a prominent role. We consider a model where a government can issue debt to both domestic and foreign investors, and we derive conditions under which their sum is the relevant state variable for default incentives. We then apply our framework to the European debt crisis. We show that matching the cyclicality of public debt ---rather than that of external debt--- allows the model to better capture the empirical distribution of interest rate spreads and gives rise to more realistic crises dynamics.
Keywords: Sovereign Debt; Default Models; European Debt Crisis
JEL Codes: E44; F34; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Total public debt (H63) | Interest rate spreads (E43) |
| Total public debt (H63) | Government's decision-making regarding default (H63) |
| Interest rate spreads (E43) | Government's decision-making regarding default (H63) |
| Total public debt (H63) | Income (D31) |