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Heterogeneous Borrowers in Quantitative Models of Sovereign Default (Revised: Sep. 2008)

By Juan Carlos Hatchondo, Leonardo Martinez and Horacio Sapriza
Working Papers
March 2007, No. 07-1R

We extend the model used in recent quantitative studies of sovereign default, allowing policymakers of different types to alternate in power. We show that a default episode may be triggered by a change in the type of policymaker in office, and that such a default is likely to occur only if there is enough political stability and if policymakers encounter poor economic conditions.  Under high political stability, political turnover enables the model to generate a weaker correlation between economic conditions and default decisions, a higher and more volatile spread, and lower borrowing levels after a default episode.

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