Private Overborrowing Under Sovereign Risk

This paper argues that excessive international private debt increases the frequency and severity of sovereign crises. I develop a quantitative theory public allows me to measure level overborrowing its effect on interest rate spread paid debt. In an environment where credit is constrained by market value income, individually optimal borrowing decisions are inefficient at aggregate level. High probability financial crisis. During such crises, drops in consumption cause decline collateral turn further reduces consumption. To mitigate this amplification mechanism, government responds with large fiscal bailouts financed risky external show response then causes crisis, characterized high spreads some cases default. find model quantitatively consistent evolution debt, Spain from 1999 2015. estimate was 5% GDP above socially lead-up Private increased annual crisis 2.4 percentage points. Finally, raised bonds least 3.8 points peak 2012.