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Economic Theory

, Volume 64, Issue 4, pp 777–804 | Cite as

Sovereign borrowing, financial assistance, and debt repudiation

  • Florian Kirsch
  • Ronald Rühmkorf
Research Article

Abstract

Official lenders provide financial assistance to countries that face sovereign debt crises. The availability of financial assistance has counteracting effects on the default incentives of governments. On the one hand, financial assistance can help to avoid defaults by bridging times of fundamental crises or resolving coordination failures among private investors. On the other hand, the insurance effect of financial assistance lowers borrowing costs, which induces the sovereign to accumulate higher debt levels. To assess the overall effect of financial assistance on the probability of default, we construct a quantitative model of endogenous credit structure and sovereign default that allows for self-fulfilling expectations of default. Calibrating the model to Argentinean data, we find that the availability of financial assistance reduces the number of defaults that occur due to self-fulfilling runs by private investors. However, at the same time, it raises average debt levels causing an overall increase in the probability of default.

Keywords

Sovereign debt Sovereign default Self-fulfilling runs Bailout 

JEL Classification

F34 G15 O19 

Notes

Acknowledgments

We thank Gernot Müller, Thomas Hintermaier, Johannes Pfeifer, Almuth Scholl, and participants at the 3rd DFG Workshop on Financial Market Imperfections and Macroeconomic Performance, the 13th SAET Conference on Current Trends in Economics, the 2013 Annual Conference of the Royal Economic Society, the 37th Simposio de la Asociación Española de Economía, the EDP Jamboree 2012, the 2nd Rhineland Workshop, the Annual Meeting of the Verein für Socialpolitik 2012, the 27th Congress of the European Economic Association, the Macro-Workshop (Bonn University), and the 3rd Conference on Recent Developments in Macroeconomics for helpful comments and discussions. Financial support by the Bonn Graduate School of Economics and the German Science Foundation (DFG) under the Priority Program 1578 is gratefully acknowledged. The views expressed in this paper are those of the authors and do not necessarily reflect those of the European Central Bank.

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Copyright information

© Springer-Verlag Berlin Heidelberg 2015

Authors and Affiliations

  1. 1.University of BonnBonnGermany
  2. 2.European Central BankFrankfurt am MainGermany

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