Essays on sovereign debt

The first chapter shows how advanced economies often have access to cheap borrowing even when they hold huge levels of debt, whereas emerging economies typically suffer from higher spreads even when they hold relatively low levels of debt. Standard sovereign debt models typically fail to explain both the "debt intolerance" that emerging countries inherit, and the "graduation" to cheaper rates that characterize developed countries. I develop a dynamic small open economy model with reputation acquisition to account for the puzzle. Information revelation is the key mechanism. A competent government wishes to transmit private information about its current income to uninformed lenders who, in turn, update their beliefs about the government's reputation for transparency. When times are bad, governments gain in the short run from misrepresenting the health of their economy, but suffer the long run cost of a lower reputation by doing so. The government cares about its reputation only indirectly because bond markets respond favorably to high reputation countries in equilibrium. The model generates a separating equilibrium in which (i) governments with a lower-than-threshold reputation are trapped with high interest rates even though they hold low levels of debt and (ii) governments with higher reputation are able borrow at lower interest rates even when they hold higher levels of debt. Chapter two examines the recent proposals of introducing common euro area sovereign securities (Eurobonds). We focus on proposals that include the introduction of guarantees with the objective of reducing the risk of default for Eurobonds, making them virtually default-free. If these proposals were implemented, Eurobonds would be a new source of financing for European governments in addition to traditional defaultable bonds. We evaluate these proposals using a model of equilibrium sovereign default augmented to allow for both defaultable and non-defaultable debt. Our simulation results indicate that introducing Eurobonds may reduce the spread on defaultable sovereign bonds significantly. However, without restrictions to defaultable debt issuances, this spread reduction is only temporal. Eurobonds do not change significantly the government's willingness to issue defaultable debt and face default risk.