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American Economic Review: Vol. 102 No. 3 (May 2012)

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Estimating Sovereign Default Risk

Article Citation

Bi, Huixin, and Nora Traum. 2012. "Estimating Sovereign Default Risk." American Economic Review, 102(3): 161-66.

DOI: 10.1257/aer.102.3.161

Abstract

This paper uses Bayesian methods to estimate the sovereign default probability for Greece and Italy in the post-EMU period. We build a real business cycle model that allows for interactions among fiscal policy instruments, sovereign default risk, and a "fiscal limit," which measures the maximum level of debt the government is willing to finance. We estimate the full nonlinear model using likelihood inference methods. Although we find that Greece historically had a lower default probability than Italy for a given debt level, our estimates suggest that the Italian government is more willing to service debt than the Greek government.

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Authors

Bi, Huixin (Bank of Canada)
Traum, Nora (NC State U)

JEL Classifications

H63: National Debt; Debt Management; Sovereign Debt
E13: General Aggregative Models: Neoclassical
G01: Financial Crises


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