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Sovereign Default Risk and Uncertainty Premia

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  • Ignacio Presno

    (Federal Reserve Bank of Boston)

  • Demian Pouzo

    (UC at Berkeley)

Abstract

This paper develops a general equilibrium model of sovereign debt with endogenous default. Foreign lenders fear that the probability model which dictates the evolution of the endowment of the borrower is misspecied. To compensate for the risk and uncertainty-adjusted probability of default, they demand higher returns on their bond holdings. In contrast with the existing literature on sovereign default, we are able to match the average bond spreads observed in the data together with the standard empirical regularities of emerging economies. The technical contribution of the paper lies in extending the methodology of McFadden (1981) to compute equilibrium allocations and prices using the discrete state space (DSS) technique in the context of risk and uncertainty aversion on the lenders' side.

Suggested Citation

  • Ignacio Presno & Demian Pouzo, 2012. "Sovereign Default Risk and Uncertainty Premia," 2012 Meeting Papers 608, Society for Economic Dynamics.
    • Handle: RePEc:red:sed012:608
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    References listed on IDEAS

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    Cited by:

    1. Aguiar, Mark & Amador, Manuel, 2014. "Sovereign Debt," Handbook of International Economics, in: Gopinath, G. & Helpman, . & Rogoff, K. (ed.), Handbook of International Economics, edition 1, volume 4, chapter 0, pages 647-687, Elsevier.
    2. Mark Aguiar & Manuel Amador, 2013. "Sovereign Debt: A Review," NBER Working Papers 19388, National Bureau of Economic Research, Inc.
    3. Ignacio Presno & Demian Pouzo, 2014. "Optimal Taxation with Endogenous Default under Incomplete Markets," 2014 Meeting Papers 689, Society for Economic Dynamics.
    4. Juan Passadore, 2015. "Illiquidity in Sovereign Debt Markets," 2015 Meeting Papers 191, Society for Economic Dynamics.

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