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Persistent gaps and default traps
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DOI：10.1016/j.jdeveco.2008.06.013.png)
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Abstract
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We show how vicious circles in countries' credit histories arise in a model where output persistence is coupled with asymmetric information about output shocks. In such an environment, default signals the borrower's vulnerability to adverse shocks and creates a pessimistic growth outlook. This translates into higher interest spreads and debt servicing costs relative to income, raising the cost of future repayments, thereby creating default traps. We build a long and broad cross-country dataset to show the existence of a history-dependent default premium and of significant effects of output persistence on sovereign creditworthiness, consistent with the model's predictions. (C) 2008 International Monetary Fund. Published by Elsevier B.V. All rights reserved.
Keywords:
Sovereign Debt
Serial default
Default premium
Emerging market bond spreads
Asymmetric information
Output persistence
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