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Juan Carlos Hatchondo - One of the best experts on this subject based on the ideXlab platform.
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Commitment and Sovereign Default risk
2018Co-Authors: Juan Carlos Hatchondo, Francisco Roch, Leonardo MartinezAbstract:We solve a Sovereign Default model with long-term debt assuming that the government can commit to future debt issuances. Comparing model simulations with and without commitment we nd that (i) commitment explains most of the Default risk in the simulations of the model without commitment, and (ii) the government wants to commit to a scal policy that is more procyclical than the one in the model without commitment. Welfare gains from commitment can be substantial.
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debt dilution and Sovereign Default risk
Journal of Political Economy, 2016Co-Authors: Juan Carlos Hatchondo, Leonardo Martinez, Cesar SosapadillaAbstract:We measure the effects of debt dilution on Sovereign Default risk and study debt covenants that could mitigate these effects. We calibrate a baseline model with endogenous debt duration and Default risk (in which debt can be diluted) using data from Spain. We find that debt dilution accounts for 78 percent of the Default risk in the baseline economy and that eliminating dilution increases the optimal duration of Sovereign debt by almost 2 years. Eliminating dilution also increases consumption volatility but still produces welfare gains. The debt covenants we study could help enforcing fiscal rules.
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Fiscal rules and the Sovereign Default premium
2012Co-Authors: Juan Carlos Hatchondo, Francisco Roch, Leonardo MartinezAbstract:We study the effects of introducing fiscal rules—understood as constraints on the decisionmaking ability of current and future governments—using a model of Sovereign Default. We first calibrate the benchmark model without a fiscal rule using as a reference an economy that pays a significant Sovereign Default premium. We then study the effects of introducing different sequences of debt ceilings. We show that the government would benefits from committing to a sequence of debt ceilings that eventually reduces its level of indebtedness enough to bring the Sovereign Default premium to negligible levels. With this commitment the government (and lenders) may benefit immediately (before any fiscal adjustment) from almost eliminating the exposure to Default risk. Benefits from imposing a fiscal rule arise even if the government is not shortsighted. Assuming that the government is shortsighted implies even larger debt reductions. Lower debt levels also allow the government to implement a less procyclical and eventually a countercyclical fiscal policy that reduces consumption volatility. Welfare gains from committing to a fiscal rule could be substantial. JEL classification: F34, F41.
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fiscal rules and the Sovereign Default premium
2012Co-Authors: Juan Carlos Hatchondo, Leonardo Martinez, Francisco RochAbstract:We find the optimal target values for fiscal rules and measure their aggregate effects using a model of Sovereign Default. We calibrate the model to an economy that pays a significant Sovereign Default premium when the government is not constrained by fiscal rules. For different levels of the Default premium, we find that a government with a debt of 38 percent of trend income (typical in the case studied here) chooses to commit to a debt ceiling of 30 percent of trend income that starts being enforced four years after its announcement. This rule generates expectations of lower future indebtedness, and thus it allows the government to borrow at interest rates significantly lower than the ones it pays without a rule. We also study the case in which the government conducts a voluntary debt restructuring to capture the capital gains from the increase in its debt market value implied by the existence of a fiscal rule. In this case, the government is found to choose instead a debt ceiling of 25 percent of trend income that starts being enforced less than two years after its announcement. After the imposition of the debt ceiling, lower debt levels allow the government to implement a less procyclical fiscal policy that reduces consumption volatility. However, the government prefers a procyclical debt ceiling that implies a larger reduction of the Default probability at the expense of a higher consumption volatility.
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fiscal rules and the Sovereign Default premium
2012Co-Authors: Juan Carlos Hatchondo, Leonardo Martinez, Francisco RochAbstract:This paper finds optimal fiscal rule parameter values and measures the effects of imposing fiscal rules using a Default model calibrated to an economy that in the absence of a fiscal rule pays a significant Sovereign Default premium. The paper also studies the case in which the government conducts a voluntary debt restructuring to capture the capital gains from the increase in its debt market value implied by a rule announcement. In addition, the paper shows how debt ceilings may reduce the procyclicality of fiscal policy and thus consumption volatility.
Horacio Sapriza - One of the best experts on this subject based on the ideXlab platform.
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quantitative properties of Sovereign Default models solution methods matter
Review of Economic Dynamics, 2010Co-Authors: Juan Carlos Hatchondo, Leonardo Martinez, Horacio SaprizaAbstract:Abstract We study the Sovereign Default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interest rate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space technique is more severe for parameterizations that feature a high sensitivity of the bond price to the borrowing level for the borrowing levels that are observed more frequently in the simulations. In addition, we find that the efficiency of the discrete state space technique can be greatly improved by (i) finding the equilibrium as the limit of the equilibrium of the finite-horizon version of the model, instead of iterating separately on the value and bond price functions and (ii) concentrating grid points in asset levels at which the bond price is more sensitive to the borrowing level and in levels that are observed more often in the model simulations. Our analysis is also relevant for the study of other credit markets.
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quantitative properties of Sovereign Default models solution methods matter
2010Co-Authors: Juan Carlos Hatchondo, Leonardo Martinez, Horacio SaprizaAbstract:We study the Sovereign Default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interestrate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space technique is more severe for parameterizations that feature a high sensitivity of the bond price to the borrowing level for the borrowing levels that are observed more frequently in the simulations. In addition, we find that the efficiency of the discrete state space technique can be greatly improved by (i) finding the equilibrium as the limit of the equilibrium of the finite-horizon version of the model, instead of iterating separately on the value and bond price functions and (ii) concentrating grid points in asset levels at which the bond price is more sensitive to the borrowing level and in levels that are observed more often in the model simulations. Our analysis is also relevant for the study of other credit markets. ; WP 10-04 replaces earlier versions listed as WP 09-13 and WP 06-11
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Quantitative Properties of Sovereign Default Models: Solution Methods Matter
Review of Economic Dynamics, 2010Co-Authors: Juan Carlos Hatchondo, Leonardo Martinez, Horacio SaprizaAbstract:We study the Sovereign Default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interest rate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space technique is more severe for parameterizations that feature a high sensitivity of the bond price to the borrowing level for the borrowing levels that are observed more frequently in the simulations. In addition, we find that the efficiency of the discrete state space technique can be greatly improved by (i) finding the equilibrium as the limit of the equilibrium of the finite-horizon version of the model, instead of iterating separately on the value and bond price functions and (ii) concentrating grid points in asset levels at which the bond price is more sensitive to the borrowing level and in levels that are observed more often in the model simulations. Our analysis questions the robustness of results in the Sovereign Default literature and is also relevant for the study of other credit markets.
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Online Appendix to "Quantitative properties of Sovereign Default models: solution methods"
2010Co-Authors: Juan Carlos Hatchondo, Leonardo Martinez, Horacio SaprizaAbstract:This document describes how we evaluate the accuracy of the solution of the baseline Sovereign Default model using the test proposed by den Haan and Marcet (1994). We show that the solutions obtained using Chebyshev collocation and cubic spline interpolation approximate the equilibrium with reasonable accuracy and illustrate the challenges that arise when the test is applied to the solution obtained using the discrete state space technique.
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Quantitative Properties of Sovereign Default Models : Solution Methods Matter, Working Paper 10-04
2010Co-Authors: Juan Carlos Hatchondo, Leonardo Martinez, Horacio SaprizaAbstract:We study the Sovereign Default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interest rate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space technique is more severe for parameterizations that feature a high sensitivity of the bond price to the borrowing level for the borrowing levels that are observed more frequently in the simulations. In addition, we find that the efficiency of the discrete state space technique can be greatly improved by (i) finding the equilibrium as the limit of the equilibrium of the finite-horizon version of the model, instead of iterating separately on the value and bond price functions and (ii) concentrating grid points in asset levels at which the bond price is more sensitive to the borrowing level and in levels that are observed more often in the model simulations. Our analysis is also relevant for the study of other credit markets. ; WP 10-04 replaces earlier versions listed as WP 09-13 and WP 06-11
Leonardo Martinez - One of the best experts on this subject based on the ideXlab platform.
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Commitment and Sovereign Default risk
2018Co-Authors: Juan Carlos Hatchondo, Francisco Roch, Leonardo MartinezAbstract:We solve a Sovereign Default model with long-term debt assuming that the government can commit to future debt issuances. Comparing model simulations with and without commitment we nd that (i) commitment explains most of the Default risk in the simulations of the model without commitment, and (ii) the government wants to commit to a scal policy that is more procyclical than the one in the model without commitment. Welfare gains from commitment can be substantial.
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debt dilution and Sovereign Default risk
Journal of Political Economy, 2016Co-Authors: Juan Carlos Hatchondo, Leonardo Martinez, Cesar SosapadillaAbstract:We measure the effects of debt dilution on Sovereign Default risk and study debt covenants that could mitigate these effects. We calibrate a baseline model with endogenous debt duration and Default risk (in which debt can be diluted) using data from Spain. We find that debt dilution accounts for 78 percent of the Default risk in the baseline economy and that eliminating dilution increases the optimal duration of Sovereign debt by almost 2 years. Eliminating dilution also increases consumption volatility but still produces welfare gains. The debt covenants we study could help enforcing fiscal rules.
-
Fiscal rules and the Sovereign Default premium
2012Co-Authors: Juan Carlos Hatchondo, Francisco Roch, Leonardo MartinezAbstract:We study the effects of introducing fiscal rules—understood as constraints on the decisionmaking ability of current and future governments—using a model of Sovereign Default. We first calibrate the benchmark model without a fiscal rule using as a reference an economy that pays a significant Sovereign Default premium. We then study the effects of introducing different sequences of debt ceilings. We show that the government would benefits from committing to a sequence of debt ceilings that eventually reduces its level of indebtedness enough to bring the Sovereign Default premium to negligible levels. With this commitment the government (and lenders) may benefit immediately (before any fiscal adjustment) from almost eliminating the exposure to Default risk. Benefits from imposing a fiscal rule arise even if the government is not shortsighted. Assuming that the government is shortsighted implies even larger debt reductions. Lower debt levels also allow the government to implement a less procyclical and eventually a countercyclical fiscal policy that reduces consumption volatility. Welfare gains from committing to a fiscal rule could be substantial. JEL classification: F34, F41.
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fiscal rules and the Sovereign Default premium
2012Co-Authors: Juan Carlos Hatchondo, Leonardo Martinez, Francisco RochAbstract:We find the optimal target values for fiscal rules and measure their aggregate effects using a model of Sovereign Default. We calibrate the model to an economy that pays a significant Sovereign Default premium when the government is not constrained by fiscal rules. For different levels of the Default premium, we find that a government with a debt of 38 percent of trend income (typical in the case studied here) chooses to commit to a debt ceiling of 30 percent of trend income that starts being enforced four years after its announcement. This rule generates expectations of lower future indebtedness, and thus it allows the government to borrow at interest rates significantly lower than the ones it pays without a rule. We also study the case in which the government conducts a voluntary debt restructuring to capture the capital gains from the increase in its debt market value implied by the existence of a fiscal rule. In this case, the government is found to choose instead a debt ceiling of 25 percent of trend income that starts being enforced less than two years after its announcement. After the imposition of the debt ceiling, lower debt levels allow the government to implement a less procyclical fiscal policy that reduces consumption volatility. However, the government prefers a procyclical debt ceiling that implies a larger reduction of the Default probability at the expense of a higher consumption volatility.
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fiscal rules and the Sovereign Default premium
2012Co-Authors: Juan Carlos Hatchondo, Leonardo Martinez, Francisco RochAbstract:This paper finds optimal fiscal rule parameter values and measures the effects of imposing fiscal rules using a Default model calibrated to an economy that in the absence of a fiscal rule pays a significant Sovereign Default premium. The paper also studies the case in which the government conducts a voluntary debt restructuring to capture the capital gains from the increase in its debt market value implied by a rule announcement. In addition, the paper shows how debt ceilings may reduce the procyclicality of fiscal policy and thus consumption volatility.
Enrique G Mendoza - One of the best experts on this subject based on the ideXlab platform.
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optimal domestic and external Sovereign Default
National Bureau of Economic Research, 2017Co-Authors: Pablo Derasmo, Enrique G MendozaAbstract:Infrequent but turbulent episodes of outright Sovereign Default on domestic creditors are considered a “forgotten history” in Macroeconomics. We propose a heterogeneous-agents model in which optimal debt and Default on domestic and foreign creditors are driven by distributional incentives and endogenous Default costs due to the value of debt for self-insurance, liquidity and risk-sharing. The government's aim to redistribute resources across agents and through time in response to uninsurable shocks produces a rich dynamic feedback mechanism linking debt issuance, the distribution of government bond holdings, the Default decision, and risk premia. Calibrated to Spanish data, the model is consistent with key cyclical co-movements and features of debt-crisis dynamics. Debt exhibits protracted fluctuations. Defaults have a low frequency of 0.93 percent, are preceded by surging debt and spreads, and occur with relatively low external debt. Default risk limits the sustainable debt and yet spreads are zero most of the time.
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optimal domestic and external Sovereign Default
Social Science Research Network, 2016Co-Authors: Enrique G Mendoza, Pablo DerasmoAbstract:Infrequent but turbulent episodes of outright Sovereign Default on domestic creditors are considered a “forgotten history” in Macroeconomics. We propose a heterogeneous-agents model in which optimal debt and Default on domestic and foreign creditors are driven by distributional incentives and endogenous Default costs due to the value of debt for self-insurance, liquidity and risk-sharing. The government's aim to redistribute resources across agents and through time in response to uninsurable shocks produces a rich dynamic feedback mechanism linking debt issuance, the distribution of government bond holdings, the Default decision, and risk premia. Calibrated to Spanish data, the model is consistent with key cyclical co-movements and features of debt-crisis dynamics. Debt exhibits protracted fluctuations. Defaults have a low frequency of 0.93 percent, are preceded by surging debt and spreads, and occur with relatively low external debt. Default risk limits the sustainable debt and yet spreads are zero most of the time.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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distributional incentives in an equilibrium model of domestic Sovereign Default
Journal of the European Economic Association, 2016Co-Authors: Pablo Derasmo, Enrique G MendozaAbstract:Europe's debt crisis resembles historical episodes of outright Default on domestic public debt about which little research exists. This paper proposes a theory of domestic Sovereign Default based on distributional incentives affecting the welfare of risk-averse debt and nondebtholders. A utilitarian government cannot sustain debt if Default is costless. If Default is costly, debt with Default risk is sustainable, and debt falls as the concentration of debt ownership rises. A government favoring bond holders can also sustain debt, with debt rising as ownership becomes more concentrated. These results are robust to adding foreign investors, redistributive taxes, or a second asset.
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distributional incentives in an equilibrium model of domestic Sovereign Default
Journal of the European Economic Association, 2016Co-Authors: Pablo Derasmo, Enrique G MendozaAbstract:The European debt crisis shares features of historical episodes of outright Default on domestic public debt about which little research has been done. This paper proposes a theory of domestic Sovereign Default in which a government chooses debt and Default optimally, responding to distributional incentives affecting the welfare of risk-averse agents who are split into debt holders and non-holders. Equilibria with debt do not exist if the government is utilitarian and Default is costless. Adding exogenous Default costs, the model supports equilibria with debt exposed to Default risk in which debt falls as the fraction of agents who own the debt falls. Debt can also be sustained if the government’s welfare weights are biased in favor of bond holders, resulting in equilibria in which debt rises as debt ownership is more concentrated. These results are robust to adding a second asset, opening the economy to foreign investors, or introducing taxes as an alternative redistributive policy instrument.
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distributional incentives in an equilibrium model of domestic Sovereign Default
National Bureau of Economic Research, 2013Co-Authors: Pablo Derasmo, Enrique G MendozaAbstract:Europe’s debt crisis resembles historical episodes of outright Default on domestic public debt about which little research exists. This paper proposes a theory of domestic Sovereign Default based on distributional incentives affecting the welfare of risk-averse debt- and non-debt holders. A utilitarian government cannot sustain debt if Default is costless. If Default is costly, debt with Default risk is sustainable, and debt falls as concentration of debt ownership rises. A government favoring bond holders can also sustain debt, with debt rising as ownership becomes more concentrated. These results are robust to adding foreign investors, redistributive taxes, or a second asset.
Pablo Derasmo - One of the best experts on this subject based on the ideXlab platform.
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banking regulation with risk of Sovereign Default
2019Co-Authors: Pablo Derasmo, Igor Livshits, Koen SchoorsAbstract:Banking regulation routinely designates some assets as safe and thus does not require banks to hold any additional capital to protect against losses from these assets. A typical such safe asset is domestic government debt. There are numerous examples of banking regulation treating domestic government bonds as ?safe,? even when there is clear risk of Default on these bonds. We show, in a parsimonious model, that this failure to recognize the riskiness of government debt allows (and induces) domestic banks to ?gamble? with depositors? funds by purchasing risky government bonds (and assets closely correlated with them). A Sovereign Default in this environment then results in a banking crisis. Critically, we show that permitting banks to gamble this way lowers the cost of borrowing for the government. Thus, if the borrower and the regulator are the same entity (the government), that entity has an incentive to ignore the riskiness of the Sovereign bonds. We present empirical evidence in support of the key mechanism we are highlighting, drawing on the experience of Russia in the run-up to its 1998 Default and on the recent Eurozone debt crisis.
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optimal domestic and external Sovereign Default
National Bureau of Economic Research, 2017Co-Authors: Pablo Derasmo, Enrique G MendozaAbstract:Infrequent but turbulent episodes of outright Sovereign Default on domestic creditors are considered a “forgotten history” in Macroeconomics. We propose a heterogeneous-agents model in which optimal debt and Default on domestic and foreign creditors are driven by distributional incentives and endogenous Default costs due to the value of debt for self-insurance, liquidity and risk-sharing. The government's aim to redistribute resources across agents and through time in response to uninsurable shocks produces a rich dynamic feedback mechanism linking debt issuance, the distribution of government bond holdings, the Default decision, and risk premia. Calibrated to Spanish data, the model is consistent with key cyclical co-movements and features of debt-crisis dynamics. Debt exhibits protracted fluctuations. Defaults have a low frequency of 0.93 percent, are preceded by surging debt and spreads, and occur with relatively low external debt. Default risk limits the sustainable debt and yet spreads are zero most of the time.
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optimal domestic and external Sovereign Default
Social Science Research Network, 2016Co-Authors: Enrique G Mendoza, Pablo DerasmoAbstract:Infrequent but turbulent episodes of outright Sovereign Default on domestic creditors are considered a “forgotten history” in Macroeconomics. We propose a heterogeneous-agents model in which optimal debt and Default on domestic and foreign creditors are driven by distributional incentives and endogenous Default costs due to the value of debt for self-insurance, liquidity and risk-sharing. The government's aim to redistribute resources across agents and through time in response to uninsurable shocks produces a rich dynamic feedback mechanism linking debt issuance, the distribution of government bond holdings, the Default decision, and risk premia. Calibrated to Spanish data, the model is consistent with key cyclical co-movements and features of debt-crisis dynamics. Debt exhibits protracted fluctuations. Defaults have a low frequency of 0.93 percent, are preceded by surging debt and spreads, and occur with relatively low external debt. Default risk limits the sustainable debt and yet spreads are zero most of the time.Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.
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distributional incentives in an equilibrium model of domestic Sovereign Default
Journal of the European Economic Association, 2016Co-Authors: Pablo Derasmo, Enrique G MendozaAbstract:Europe's debt crisis resembles historical episodes of outright Default on domestic public debt about which little research exists. This paper proposes a theory of domestic Sovereign Default based on distributional incentives affecting the welfare of risk-averse debt and nondebtholders. A utilitarian government cannot sustain debt if Default is costless. If Default is costly, debt with Default risk is sustainable, and debt falls as the concentration of debt ownership rises. A government favoring bond holders can also sustain debt, with debt rising as ownership becomes more concentrated. These results are robust to adding foreign investors, redistributive taxes, or a second asset.
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distributional incentives in an equilibrium model of domestic Sovereign Default
Journal of the European Economic Association, 2016Co-Authors: Pablo Derasmo, Enrique G MendozaAbstract:The European debt crisis shares features of historical episodes of outright Default on domestic public debt about which little research has been done. This paper proposes a theory of domestic Sovereign Default in which a government chooses debt and Default optimally, responding to distributional incentives affecting the welfare of risk-averse agents who are split into debt holders and non-holders. Equilibria with debt do not exist if the government is utilitarian and Default is costless. Adding exogenous Default costs, the model supports equilibria with debt exposed to Default risk in which debt falls as the fraction of agents who own the debt falls. Debt can also be sustained if the government’s welfare weights are biased in favor of bond holders, resulting in equilibria in which debt rises as debt ownership is more concentrated. These results are robust to adding a second asset, opening the economy to foreign investors, or introducing taxes as an alternative redistributive policy instrument.
