Working Paper 723

Sovereign Default: The Role of Expectations

Juan Pablo Nicolini | Senior Research Economist
Pedro Teles
Joao Luiz Ayres | Research Analyst
Gaston Navarro

Published May 14, 2015

Abstract
We study a variation of the standard model of sovereign default, as in Aguiar and Gopinath (2006) or Arellano (2008), and show that this variation is consistent with multiple interest rate equilibria. Some of those equilibria correspond to the ones identified by Calvo (1988), where default is likely because rates are high, and rates are high because default is likely. The model is used to simulate equilibrium movements in sovereign bond spreads that resemble sovereign debt crises. It is also used to discuss lending policies similar to the ones announced by the European Central Bank in 2012.


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