DP13202 Rare Disasters, Financial Development, and Sovereign Debt

Author(s): Sérgio Rebelo, Neng Wang, Jinqiang Yang
Publication Date: September 2018
Date Revised: August 2019
Keyword(s): Financial Development, Sovereign debt
JEL(s): F34
Programme Areas: Financial Economics, International Macroeconomics and Finance
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=13202

We propose a model of sovereign debt where countries vary in their level of financial development, defined as the extent to which countries can hedge rare disasters in in- ternational capital markets. We show that low levels of financial development generate the "debt intolerance" phenomenon that plagues emerging markets: it reduces debt capacity, increases credit spreads, and limits the ability to smooth consumption.