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Sovereign default, domestic banks and financial institutions
Gennaioli, Nicola; Martin, Alberto; Rossi, Stefano
Universitat Pompeu Fabra. Departament d'Economia i Empresa
We present a model of sovereign debt in which, contrary to conventional wisdom, government defaultsare costly because they destroy the balance sheets of domestic banks. In our model, better financial institutionsallow banks to be more leveraged, thereby making them more vulnerable to sovereign defaults.Our predictions: government defaults should lead to declines in private credit, and these declines should belarger in countries where financial institutions are more developed and banks hold more government bonds.In these same countries, government defaults should be less likely. Using a large panel of countries, we findevidence consistent with these predictions.
02-11-2009
Macroeconomics and International Economics
sovereign risk
capital flows
institutions
financial liberalization
sudden stops.
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