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Volatility and Sovereign Default

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  • Luisa Lambertini

    (Boston College)

Abstract

The history of international lending shows that countries default on external debt when their economies experience a downturn. This paper presents a theoretical model of international lending that is consistent with this evidence. In this model, output is stochastic, international capital markets are incomplete because borrowing can only occur via issuing bonds, and borrowers cannot commit to repay loans. Self-fulfilling and solvency debt crises arise when borrowers experience low output realizations; moreover, when lenders are atomistic, self- fulfilling crises may arise for debt levels that do not cause default when lenders are non-atomistic. Alternative reforms to eliminate liquidity crises are analyzed. An international lender of last resort can eliminate liquidity crises provided it implements full bailouts via purchasing debt at its market price.

Suggested Citation

  • Luisa Lambertini, 2001. "Volatility and Sovereign Default," Boston College Working Papers in Economics 577, Boston College Department of Economics.
    • Handle: RePEc:boc:bocoec:577
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    References listed on IDEAS

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    Cited by:

    1. Antoine Martin, 2002. "Reconciling Bagehot with the Fed's response to Sept. 11," Research Working Paper RWP 02-10, Federal Reserve Bank of Kansas City.

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    More about this item

    Keywords

    Sovereign debt; Default; Self-fulfilling Crises;
    All these keywords.

    JEL classification:

    • F3 - International Economics - - International Finance
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems

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