Essays on Sovereign Default with Information Frictions
2022-06
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Essays on Sovereign Default with Information Frictions
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2022-06
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This dissertation consists of three chapters. In the first chapter, I build a flexible theoretical model of sovereign borrowing, default, and renegotiation with borrower reputation. There is asymmetric information about the government's ``type'', and reputation is the market belief that it is ``responsible'' and therefore less likely to default. Every government decision informs market beliefs about this ``type''. I calibrate the model using data on how countries' credit histories affect the prices they face. Using the model, I show that countries that have recently defaulted have poor reputations because they rapidly run up their debts prior to default, not because the default decision itself is revealing. I also show that, for countries facing non-trivial levels of default risk, the reputational costs of default are less than $0.2$ basis points of consumption. I then validate the model by showing that its predictions about the effects of borrowing behavior on interest rate spreads through the reputation channel are borne out in the data. Finally, I show that transparency initiatives and audit programs have significant, negative implications for welfare, because they weaken the signaling mechanisms that prevent, to some extent, overborrowing by the government. In the second chapter, I document that, during the height of the Eurozone Debt Crisis in Spain, 1.) Spanish government bonds became substantially less liquid and less traded on secondary markets, 2.) the first appearance of this phenomenon lagged far behind the initial jump in interest rate spreads in late 2008, and 3.) it persisted throughout the period of peak interest rate spreads and only subsided after the worst of the crisis had passed. I argue that these facts are related and best explained by a model of sovereign default that features secondary markets in which it is possible that some traders have private information. I then build a model in which some traders have private information about the country's future economic conditions and show that this allows the model to reproduce both the delayed reaction of bid-ask spreads as well as their peak and behavior during the height of the crisis. Using the model, I measure the losses to investors associated with variation in liquidity during debt crises. Finally, I validate the model by showing that the model's predicted relationship between current, realized bid-ask spreads and future values of GDP allows me to forecast GDP significantly better than a standard, benchmark forecast. In the third chapter, I document that, during the Eurozone Debt Crises, 1.) forecasts of output were persistently biased upwards, 2.) the afflicted countries all saw steep increases in their government debt to GDP ratios and their external government debt to GDP ratios, and 3.) spreads reacted slowly to these increases. I argue that these three facts are related and connect them through a model of sovereign default which features incomplete information with respect to the persistent component of output. I then show that the inclusion of information imperfections allows the model to produce patterns during and before crises which better match the patterns in the data than the benchmark model.
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University of Minnesota Ph.D. dissertation. June 2022. Major: Economics. Advisors: Manuel Amador, Timothy Kehoe. 1 computer file (PDF); ix, 164 pages.
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Fourakis, Stelios. (2022). Essays on Sovereign Default with Information Frictions. Retrieved from the University Digital Conservancy, https://hdl.handle.net/11299/241584.
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