Maturity, Indebtedness and Default Risk
by Satyajit Chatterjee of the Federal Reserve Bank of Philadelphia, and
Abstract: In this paper, we present a tractable model of long-term sovereign debt and explore its implications for levels of sovereign debt and default spreads. Using Argentina as a test case, we show that our model of long-term sovereign debt is capable of explaining both the average spread (or, equivalently, default probability), the average debt-to-output ratio and the volatility of consumption relative to output during the ten years preceding Argentina's most recent default episode (in 2002). We show that our model of long-term sovereign debt improves upon models with short-term debt in that short-term sovereign debt models seem incapable of explaining all three facts for Argentina. We also use our model to answer a counterfactual: What would debt levels, spreads, consumption volatility and be if Argentina had issued only short-term debt?
Keywords: Unsecured Debt, Sovereign Debt, Long Duration Bonds, Debt Dilution, Random Maturity Bonds, Default Risk.