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Optimal external debt and default

Guimaraes, Bernardo (2008) Optimal external debt and default. CEPDP847. Centre for Economic Performance, London School of Economics and Political Science, London, UK.

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This paper analyses whether sovereign default episodes can be seen as contingencies of optimal international lending contracts. The model considers a small open economy with capital accumulation and without commitment to repay debt. Taking first order approximations of Bellman equations, I derive analytical expressions for the equilibrium level of debt and the optimal debt contract. In this environment, debt relief generated by reasonable fluctuations in productivity is an order of magnitude below that generated by shocks to world interest rates. Debt relief prescribed by the model following the interest rate hikes of 1980-81 accounts for a substantial part of the debt forgiveness obtained by the main Latin American countries through the Brady agreements.

Item Type: Monograph (Discussion Paper)
Official URL:
Additional Information: © 2008 The Author
Library of Congress subject classification: H Social Sciences > HJ Public Finance
Journal of Economic Literature Classification System: F - International Economics > F4 - Macroeconomic Aspects of International Trade and Finance
G - Financial Economics > G1 - General Financial Markets
F - International Economics > F3 - International Finance
Sets: Collections > Economists Online
Research centres and groups > Centre for Economic Performance (CEP)
Departments > Economics
Identification Number: CEPDP847
Date Deposited: 28 Feb 2008

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