Job Market Paper
Abstract: In this paper, 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.
Aguiar, Mark, Manuel Amador, and Stelios Fourakis (2020): “On the Welfare Losses from External Sovereign Borrowing,” IMF Economic Review, 68(1): 163-194.
Abstract: This paper studies the losses to the citizenry when the private agents discount the future at different rates from their government. In the presence of such a disagreement, the private sector may prefer an environment in which the government is in financial autarky. Using a sequence of sovereign debt models, the paper quantifies the potential welfare losses that citizens suffer from the government’s access to international bond markets. While the environment is not necessarily comprehensive, the analysis provides a counterweight to proposals that are designed to ease market access for sovereign borrowers.
Abstract: In this paper, 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.
Computing Sovereign Debt Models: Why So Hard?
Joint with Mark Aguiar and Manuel Amador
Abstract: Sovereign debt models with long-duration bonds are notoriously hard to compute. Using a simplified environment of the standard Eaton & Gersovitz (1981) model with outside option shocks, we show that equilibria in pure strategies may not exist, explaining the lack-of-convergence issues encountered in the quantitative literature. We propose an algorithm for computing mixed-strategy equilibria. For some parameterizations, we uncover millions.
Long Term Debt Models: Solution Methods Matter
Abstract: Over the last decade, long term debt has become a standard feature in quantitative studies of sovereign default. A wide variety of numerical solution methods have been used in solving these models, but little is known about the relative performance of various methods and their sensitivity to parameters and grid specifications. In this paper, I provide a survey of the commonly used methods and then test their performance. For long run simulations (often used to calculate the moments used to estimate the model), I find that results (both within each method, varying grid fineness, and across methods) are relatively stable. However, for short run simulations (often used to analyze the model's prediction about a specific country's experience at a specific time of interest), the results can vary dramatically. In some cases, the results even change qualitatively. Using these results, I provide guidance on when each method is likely to be robust and when it is probably the case that results are not robust to the choice of solution method (and specific parameters of that solution method, such as grid fineness).
Abstract: In this paper, 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.