Creator: Alvarez, Fernando, 1964- and Jermann, Urban J. Series: Endogenous incompleteness Abstract:
We study the asset pricing implications of a multi-agent endowment economy where agents can default on debt. We build on the environment studied by Kocherlakota (1995) and Kehoe and Levine (1993). We present an equilibrium concept for an economy with complete markets and with endogenous solvency constraints. These solvency constraints prevent default, but at the cost of reduced risk sharing. We show that versions of the classical welfare theorems hold for this equilibrium definition. We characterize the pricing kernel, and compare it to the one for economies without participation constraints: interest rates are lower and risk premia depend on the covariance of the idiosyncratic and aggregate shocks.
Keyword: Equilibrium, Default, Solvency constraints, Risk, Shocks, and Assets Subject (JEL): G12 - General financial markets - Asset pricing ; Trading volume ; Bond interest rates and D50 - General equilibrium and disequilibrium - General
Creator: Da-Rocha, Jose-Maria., Giménez Fernández, Eduardo Luís., and Lores Insua, Francisco Xavier. Series: Advances in dynamic economics Abstract:
In this paper we will consider a simple small open economy with three assets - domestic capital, foreign securities and public debt - to study the government's incentives to devalue and to repay or default the debt. We show that the announcement of a devaluation is anticipated by domestic agents who reduce domestic investments and increase foreign holdings. Once a government devalues, the expectations vanish and the economy recovers its past levels of investment and GDP. However, in a country with international debt denominated in US dollars if a government devalues it requires a higher fraction of GDP to repay its external debt. In consequence, there exists a trade-off between recovering the economy and increasing the future cost of repaying the debt. Our main result is to show that, as devaluation beliefs exists, a devaluation increase government incentives to default and devalue. We calibrate our model to match the decrease in investment of domestic capital, the reduction in production, the increase in trade balance surplus, and the increase in debt levels observed throughout 2001 in Argentina. We show that for a probability of devaluation consistent with the risk premium of the Argentinian Government bonds nominated in dollars issued on April 2001 the external debt of Argentina was in a crisis zone were the government find optimal to default and to devalue.
Keyword: South America, Default, Argentina, Latin America, Devaluation, and Debt crisis Subject (JEL): F30 - International finance - General, E60 - Macroeconomic policy, macroeconomic aspects of public finance, and general outlook - General, and F34 - International finance - International lending and debt problems