English, Article, Journal or magazine article edition: Sovereign Risk and Secondary Markets Fernando Broner; Alberto Martin; Jaume Ventura

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Bookmark: http://trove.nla.gov.au/version/155488
Physical Description
  • preprint
Language
  • English

Edition details

Title
  • Sovereign Risk and Secondary Markets
Author
  • Fernando Broner
  • Alberto Martin
  • Jaume Ventura
Physical Description
  • preprint
Notes
  • Conventional wisdom says that, in the absence of sufficient default penalties, sovereign risk constrains credit and lowers welfare. We show that this conventional wisdom rests on one implicit assumption: that assets cannot be retraded in secondary markets. Once this assumption is relaxed, there is always an equilibrium in which sovereign risk is stripped of its conventional effects. In such an equilibrium, foreigners hold domestic debts and resell them to domestic residents before enforcement. In the presence of (even arbitrarily small) default penalties, this equilibrium is shown to be unique. As a result, sovereign risk neither constrains welfare nor lowers credit. At most, it creates some additional trade in secondary markets. The results presented here suggest a change in perspective regarding the origins of sovereign risk and its remedies. To argue that sovereign risk constrains credit, one must show both the insufficiency of default penalties and the imperfect workings of secondary markets. To relax credit constraints created by sovereign risk, one can either increase default penalties or improve the workings of secondary markets.
  • RePEc:nbr:nberwo:12783
  • Conventional wisdom says that, in the absence of default penalties, sovereign risk destroys all foreign asset trade. We show that this conventional wisdom rests on one implicit and extreme assumption: that assets cannot be retraded in secondary markets. Once this assumption is relaxed, foreign asset trade is possible even in the absence of default penalties. In fact, in the —also extreme— case of frictionless secondary markets sovereign risk does not affect foreign asset trade. Overall, the results presented in this paper suggest a broader perspective regarding the origins of sovereign risk and its remedies. Sovereign risk affects foreign asset trade only if both, default penalties are insufficient and secondary markets work imperfectly. To reduce the effects of sovereign risk, one can either increase default penalties or improve the workings of secondary markets.
  • Sovereign risk, secondary markets, default penalties, commitment, international risk sharing, international borrowing
  • RePEc:upf:upfgen:998
Language
  • English
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