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In Rememberance: World Trade Center (WTC)

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Maturity, Indebtedness and Default Risk

by Satyajit Chatterjee of the Federal Reserve Bank of Philadelphia, and
Burcu Eyigungor of Koç University

December 2008

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.

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