Ex-ante implications of sovereign default

Samreen Malik

    Research output: Contribution to journalArticle

    Abstract

    I study how the possibility of default on external debts affects other capital allocation decisions in a small open economy. In the model, default has an option value derived from the randomization over ex-post default regimes, which depends on country-specific productivity shocks. This feature of default reduces incentives for ex-ante diversification, which would reduce exposure to the productivity shock. As a result, if the economys debt to capital ratio is allowed to cross a fixed threshold (identified in the model), the unique equilibrium exhibits an allocation of capital that is less productive in expectation and more volatile than in a benchmark model without default. The model therefore captures a number of salient features of emerging and less developed countries, where low levels of international risk-sharing have gone hand-in-hand with frequent and recurring default events.

    Original languageEnglish (US)
    Pages (from-to)386-397
    Number of pages12
    JournalJournal of Banking and Finance
    Volume49
    DOIs
    StatePublished - Dec 1 2014

    Fingerprint

    Sovereign default
    Productivity shocks
    Option value
    Less developed countries
    Small open economy
    Capital allocation
    Benchmark
    External debt
    Randomization
    Incentives
    International risk sharing
    Capital ratios
    Diversification
    Debt

    Keywords

    • Financial integration
    • Option-value
    • Sovereign defaults
    • Threshold effects

    ASJC Scopus subject areas

    • Economics and Econometrics
    • Finance

    Cite this

    Ex-ante implications of sovereign default. / Malik, Samreen.

    In: Journal of Banking and Finance, Vol. 49, 01.12.2014, p. 386-397.

    Research output: Contribution to journalArticle

    Malik, Samreen. / Ex-ante implications of sovereign default. In: Journal of Banking and Finance. 2014 ; Vol. 49. pp. 386-397.
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