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Persistent gaps and default traps

By L.A.V. Catao, A. Fostel and Sandeep Kapur

Abstract

We show how vicious circles in countries' credit histories arise in a model where output persistence is coupled with asymmetric information about output shocks. In such an environment, default signals the borrower's vulnerability to adverse shocks and creates a pessimistic growth outlook. This translates into higher interest spreads and debt servicing costs relative to income, raising the cost of future repayments, thereby creating “default traps”. We build a long and broad cross-country dataset to show the existence of a history-dependent “default premium” and of significant effects of output persistence on sovereign creditworthiness, consistent with the model's predictions

Topics: ems
Publisher: Elsevier
Year: 2009
OAI identifier: oai:eprints.bbk.ac.uk.oai2:1959

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