In this chapter, we use a benchmark limited-commitment model to explore key issues in the economics of sovereign debt. After highlighting conceptual issues that distinguish sovereign debt as well as reviewing a number of empirical facts, we use the model to discuss debt overhang, risk sharing, and capital flows in an environment of limited enforcement. We also discuss recent progress on default...

We show that sovereign debt impairments can have a significant impact on financial markets and real economies through a credit ratings channel. Specifically, we find that firms reduce their investment and reliance on credit markets due to a rising cost of debt capital following a sovereign rating downgrade. We identify these effects by exploiting exogenous variation on corporate ratings due to ...

This paper develops a quantitative general equilibrium model of sovereign default with heterogenous agents to account for spillover of default risk across countries. Borrowers (sovereign governments) and foreign lenders (investors) in the model face financial frictions, which endogenously determine each agent’s credit condition. Due to lack of enforcement in sovereign debt, borrowing constraint...

The stock of sovereign debt is typically measured at face value. Defined as the undiscounted sum of future principal repayments, face values are misleading when debts are issued with different contractual forms or maturities. In this paper, we construct alternative measures of the stock of external sovereign debt for 100 developing countries from 1979 through 2006 that correct for differences i...

India’s expansionary fiscal policy during the recent crisis resulted in higher government borrowing through 2008–09 and 2009–10. This borrowing requirement came in about 83% above the budget estimate in 2008–09, and 65% above the previous year in 2009–10. The debt-to-GDP ratio rose from 69% before the recent global financial crisis to 73% in 2010, creating a severe challenge for the Reserve Ban...

During the last two years, Europe has been facing a debt crisis, and Greece has been at its center. In response to the crisis, drastic actions have been taken, including the halving of Greek debt. Policy makers acted because interest rates for sovereign debt increased dramatically. High interest rates imply that default is likely due to economic conditions. High interest rates also increase the...

This paper sets out to explore the potential of sub-sovereign bonds in financing infrastructure in developing countries. Taking into account the historical experience of the US, it develops a supply and demand side framework for analysis of the market for sub-sovereign bonded debt in developing countries and applies this framework to Mexico, India and South Africa. Finally, it draws lessons for...

Recent empirical evidence suggests that the major cost of sovereign default lies in its effects on the domestic financial system, rather than any external sanctions. To explore this link, we extend the banking model of Gertler and Karadi (2011) to allow banks to hold risky long-term government debt, and then incorporate bank runs following Gertler and Kiyotaki (2013). Banks face an agency probl...

This paper reviews the lessons learned from the application of the tools of game theory to the theoretical study of sovereign debt and default. We focus on two main questions. First, we review answers to the most fundamental question in the theory of sovereign debt: given that there is no supranational institution for enforcing the repayment of debts, why do countries ever repay their debts? Se...