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http://hdl.handle.net/10419/53957
  
Title:Sovereign default risk premia, fiscal limits and fiscal policy PDF Logo
Authors:Bi, Huixin
Issue Date:2011
Series/Report no.:Bank of Canada Working Paper 2011,10
Abstract:We develop a closed economy model to study the interactions among sovereign risk premia, fiscal limits, and fiscal policy. The stochastic fiscal limits, which measure the ability and willingness of the government to service its debt, arise endogenously from a dynamic Laffer curve. The distribution of fiscal limits is country-specific, depending on the size of the government, the degree of countercyclical policy responses, economic diversity, and political uncertainty, among other characteristics. The model rationalizes different sovereign ratings across developed countries. A nonlinear relationship between sovereign risk premia and the level of government debt, which emerges in equilibrium, is consistent with the empirical evidence that once risk premia begin to rise, they do so rapidly. Movements in default risk premia for long-term bonds precede those for shortterm bonds, providing early warnings of increasing probabilities of sovereign defaults.
Subjects:Fiscal policy
International topics
JEL:E62
H30
H60
Document Type:Working Paper
Appears in Collections:Bank of Canada Working Papers

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