A Risk Management Approach to Emerging Markets Sovereign Debt Sustainability with an Application to Brazilian Data

by Márcio Gomes Pinto Garcia of Pontifícia Universidade Católica do Rio de Janeiro, and
Roberto Rigobon of the Massachusetts Institute of Technology

March 17, 2004

Abstract: In this paper we study the question of debt sustainability from a risk management perspective. The debt accumulation equation for any country involves variables that are stochastic and closely intertwined. When these aspects are taken into consideration the notion of debt sustainability is expanded to studying the stochastic properties of the debt dynamics. We illustrate the methodology by studying the Brazilian case. We find that even though the debt could be sustainable in the absence of risk, there are paths in which it is clearly unsustainable. Furthermore, we show that properties of the debt dynamics are closely related to the spreads on sovereign dollar denominated debt.

JEL Classification: F34, F37, G15.

Keywords: Public Debt, Debt Sustainability, Country Risk, Brazil.

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