Arbeitspapier
Optimal sovereign default
When is it optimal for a government to default on its legal repayment obligations? We answer this question for a small open economy with domestic production risk in which contracting frictions make it optimal for the government to finance itself by issuing non-contingent debt. We show that Ramsey optimal policies occasionally deviate from the legal repayment obligation and repay debt only partially, even if such deviations give rise to significant 'default costs'. Optimal default improves the international diversification of domestic output risk, increases the efficiency of domestic investment and - for a wide range of default costs - significantly increases welfare relative to a situation where default is simply ruled out from Ramsey optimal plans. We show analytically that default is optimal following adverse shocks to domestic output, especially for very negative international wealth positions. A quantitative analysis reveals that for empirically plausible wealth levels, default is optimal only in response to disaster-like shocks to domestic output, and that following such shocks default can be Ramsey optimal even if the net foreign asset position is positive.
- ISBN
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978-3-86558-896-8
- Language
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Englisch
- Bibliographic citation
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Series: Bundesbank Discussion Paper ; No. 09/2013
- Classification
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Wirtschaft
Fiscal Policy
International Lending and Debt Problems
- Subject
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Fiscal Policy
Sovereign Risk
- Event
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Geistige Schöpfung
- (who)
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Adam, Klaus
Grill, Michael
- Event
-
Veröffentlichung
- (who)
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Deutsche Bundesbank
- (where)
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Frankfurt a. M.
- (when)
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2013
- Handle
- Last update
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10.03.2025, 11:43 AM CET
Data provider
ZBW - Deutsche Zentralbibliothek für Wirtschaftswissenschaften - Leibniz-Informationszentrum Wirtschaft. If you have any questions about the object, please contact the data provider.
Object type
- Arbeitspapier
Associated
- Adam, Klaus
- Grill, Michael
- Deutsche Bundesbank
Time of origin
- 2013
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Calibration alternatives to logistic regression and their potential for transferring the dispersion of discriminatory power into uncertainties of probabilities of default
Optimal degrees of transparency in monetary policymaking
A value at risk analysis of credit default swaps
Recent developments in quantitative models of sovereign default
Sovereign default swap market efficiency and country risk in the eurozone
Optimal Sovereign Default
Updating the option implied probability of default methodology
What can EMU countries' sovereign bond spreads tell us about market perceptions of default probabilities during the recent financial crisis?
Estimating probabilities of default for German savings banks and credit cooperatives
Sovereign risk and bank fragility
Market conditions, default risk and credit spreads
Spillover effects of credit default risk in the euro area and the effects on the euro: A GVAR approach
Calibration alternatives to logistic regression and their potential for transferring the dispersion of discriminatory power into uncertainties of probabilities of default
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