Sovereign Risk and Secondary Markets / Fernando Broner, Alberto Martin, Jaume Ventura.

Format:

Book

Author/Creator:

Broner, Fernando.

Contributor:

National Bureau of Economic Research.

Martin, Alberto.

Ventura, Jaume.

Series:

Working Paper Series (National Bureau of Economic Research) no. w12783.

NBER working paper series no. w12783

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2006.

Summary:

Conventional wisdom says that, in the absence of sufficient default penalties, sovereign risk constrains credit and lowers welfare. We show that this conventional wisdom rests on one implicit assumption: that assets cannot be retraded in secondary markets. Once this assumption is relaxed, there is always an equilibrium in which sovereign risk is stripped of its conventional effects. In such an equilibrium, foreigners hold domestic debts and resell them to domestic residents before enforcement. In the presence of (even arbitrarily small) default penalties, this equilibrium is shown to be unique. As a result, sovereign risk neither constrains welfare nor lowers credit. At most, it creates some additional trade in secondary markets. The results presented here suggest a change in perspective regarding the origins of sovereign risk and its remedies. To argue that sovereign risk constrains credit, one must show both the insufficiency of default penalties and the imperfect workings of secondary markets. To relax credit constraints created by sovereign risk, one can either increase default penalties or improve the workings of secondary markets.

Notes:

Print version record

December 2006.