Unsustainability and Sovereign default: Looking for the right haircut

Tax Administration Research Centre (TARC)

Speaker:Hubert Kempf, Paris School of Economics
Website: http://ces.univ-paris1.fr/membre/Kempf/Default.htm
Date: Wednesday 28 May 2014
Time: 15:30
Location: Bateman Lecture Theatre, Building: One

Further details

We address several issues related to sovereign default in a macroeconomic model: its causes, its frequency and the public management of default. Taking into account a default rule, we distinguish the “default threshold” from the “unsustainability threshold”.  The former corresponds to the upper limit of public debt beyond which the default occurs with unit probability, the later one to the threshold beyond which, absent any further shocks, the dynamics of public debt leads inevitably to a future default. Both thresholds depend on the haircut applied to the amount of debt in case of default and specified by the default rule (or simply perceived by the market). We show that “successful default” is such that the post-default risk premium is small enough and contributes to a decreasing debt-to-output ratio. This implies that the haircut on public debt must be sufficiently high.