Endogenous political turnover and fluctuations in sovereign default risk

Abstract

A sovereign default model in which the sovereign derives private benefits from public office and contests elections to stay in power is developed. The economy's growth process is modeled as a Markov switching regime, which is shown to be a better description of the data for our set of emerging economies. In the model, consistent with evidence, the sovereign is less likely to be reelected if economic growth is weak. In the low-growth regime, there is higher probability of loss of private benefits due to turnover, which makes the sovereign behave more myopically. This growth-linked variation in effective discount factor is shown to be important in generating volatility in sovereign spreads.

Fiscal Rules and Sovereign Default

“…We analyze the robustness of the quantitative implications of our results to different assumptions and parameter values. In terms of the role of debt, the hypothesis that governments benefit from borrowing and thus have a motive to hold positive amounts of Chatterjee and Eyigungor (2016b), the calibrated debt levels are still much lower than in the data. 3 Two additional features make Brazil particularly interesting.…”

Incumbency Disadvantage in U.S. National Politics: The Role of Policy Inertia and Prospective Voting

“…Finally, our paper makes a methodological contribution by augmenting the toolkit of researchers using quantitative theory to study partisan politics with endogenous reelection probabilities. Such games can be hard to compute because of the possible lack of continuity of Markovian decision rules (Chatterjee and Eyigungor (2016)) and, consequently, the possible nonexistence of a pure strategy equilibrium. By incorporating a continuously distributed i.i.d.…”

“…Prospective voting and endogenous reelection probabilities have recently featured in quantitative models of sovereign debt and default. 6 Scholl (2017) uses a version of the Persson and Svensson's (1989) partisan politics model to quantitatively explore the implications of endogenous reelection probabilities on sovereign borrowing and default behavior, and Chatterjee and Eyigungor (2017) study the role of prospective voting in accounting for observed fluctuations in the risk of sovereign default in emerging economies. But incumbency disadvantage is not a necessary feature of these models.…”

“…The potential lack of continuity of decision rules and, therefore, of the mapping whose fixed points are pure strategy Markov equilibria, also plagues models of sovereign debt and default(Chatterjee and Eyigungor (2012)) and models of legislative bargaining(Duggan and Kalandrakis (2012)). In both instances, the existence problem is solved by the addition of continuously distributed random shocks in the appropriate places.…”

“…However, the existence proofs given in these papers cannot be used to claim existence for the present model since a key element of the present model -endogenous reelection probability -is missing in these earlier papers. InDuggan and Kalandrakis (2012), proposer election probabilities are an exogenous function of the state and inChatterjee and Eyigungor (2012) there is no political turnover of the sovereign at all.…”