Working Paper

Maturity, indebtedness, and default risk

Abstract: In this paper, the authors present a new approach to incorporating long-term debt into equilibrium models of unsecured debt and default. They make three sets of contributions. First, the authors advance the theory of sovereign debt begun in Eaton and Gersovitz (1981) by proving the existence of an equilibrium price function with the property that the interest rate on debt is increasing in the amount borrowed. Second, using Argentina as a test case, they show that unlike a one-period debt model, their model of long-term debt is capable of accounting for the average external debt-to-output ratio, average spread on external debt, and the standard deviation of spreads for the 1993-2001 period, without any deterioration in the model's ability to account for Argentina's other cyclical facts. Third, the authors propose a new and very accurate method for solving the model.

Keywords: Debt; Default (Finance); Econometric models;

Bibliographic Information

Provider: Federal Reserve Bank of Philadelphia

Part of Series: Working Papers

Publication Date: 2010

Number: 10-12