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    Persistent gaps and default traps

    Catao, L.A.V. and Fostel, A. and Kapur, Sandeep (2008) Persistent gaps and default traps. Working Paper. Birkbeck College, University of London, London, UK.

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    Abstract

    We show how vicious circles in countries' credit histories arise in a model where output persistence is coupled with asymmetric information between borrowers and lenders about the nature of output shocks. In such an environment, default creates a pessimistic outlook about the borrower's output path. This translates into higher debt-to-expected-output ratios, pushing up interest rates and hence debt servicing costs. By raising the cost of future repayments, this creates "default traps". We provide empirical support for the model by building a long and broad cross-country dataset spanning over a century. This data is used to provide evidence on the existence of a history-dependent "default premium" and to show that the effect of output persistence on sovereign creditworthiness is significant and consistent with the model's predictions after controlling for other determinants of sovereign risk.

    Metadata

    Item Type: Monograph (Working Paper)
    Additional Information: BWPEF 0803
    Keyword(s) / Subject(s): Sovereign default, spreads, persistence
    School: Birkbeck Schools and Departments > School of Business, Economics & Informatics > Economics, Mathematics and Statistics
    Depositing User: Administrator
    Date Deposited: 09 Jul 2013 07:26
    Last Modified: 09 Jul 2013 07:26
    URI: http://eprints.bbk.ac.uk/id/eprint/7593

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