Publication: Sovereign default and asymmetric market information
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2014-10
Defense date
2014-11-03
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Abstract
It is not a novelty that emerging market economies are prone to poor institutions, additional
layers of uncertainty and lack of transparency. There is quite a signi cant body of literature
that shows the negative e ects due to lack of transparency. Among others, Gelos and Wei
(2005) provide evidence that less transparent countries receive less investment and that
during crisis they are more likely to experience high capital out ows.1 Marques, Gelos, and
Melgar (2013) document that more opaque countries su er more from nancial globalization.
Several economic crises have been partially worsened by lack of transparency. For instance,
in the recent Asian crisis, Thai government has been accused of allowing an extremely
opaque nancial sector to ourish. It is considered to be one of the key elements
that triggered the nancial turmoil in 1997. The 2008-2009 debt crisis has shown that, eventually,
no country is shielded from high interest rate spreads, unsustainable debt and lack
of transparency. Even developed countries like Spain and Greece have been undermined by
revealed hidden debts, economic uncertainty and respectively una ordable borrowing costs. 2
The lack of transparency practiced by a range of countries is puzzling.
In present work, I study the implications of information asymmetry, that appears between
government and lenders, on economic outcomes and analyze the conditions when
governments prefer to be less transparent about their states of economy. In particular, the
thesis focuses on the joint dynamics of asymmetric information between market participants and sovereign debt and default.
In part I, Sovereign Debt and asymmetric market information", I show that in an environment
when government is less uncertain about the future state of the economy than
lenders are, the former ends up borrowing higher amount of debt and defaults more often. I
start with bringing some evidence that shows a positive correlation between the debt to GDP
level and future economic uncertainty (proxied by root mean square of GDP growth forecast
errors) for di erent countries. Then, I extend the recent quantitative models of sovereign
default by allowing asymmetry in information between the government and foreign lenders.
The key ingredients are the information about future endowment and its accuracy which are
received by market participants. The obtained results can be explained by the fact that in an
environment when lenders observe more accurate information, the gains for the government
when lenders observe good news are less than costs that are coming from lenders observing
bad news. Therefore, on average, government ends up borrowing more when lenders are less
informed about future endowment and o er a relatively better price. Chapter 1 focuses on
the mechanism of the model and explains how the information precision a ects the level of
demanded debt. In chapter 2, I simulate a small open economy and compare the results to
the existing literature of endogenous sovereign default.
In part II, Optimal Transparency", I study the economic conditions when government
prefers to be less transparent about its state of economy. For this purpose, I develop a dynamic
model of endogenous sovereign default with private information where both government
and lenders act strategically and can update their beliefs upon observing government's
actions. I nd that a government prefers to be opaque when it is overindebted, expects a
more severe crisis, but with a lower probability. The rst two results are intuitive. A government
that has high current debt or expects that recession is going to be more pronounced
depends more on the external resources to nance its consumption. Therefore, a government
that is experiencing a boom prefers to bear the cost of lower asset price so that it can enjoy
a higher consumption if, eventually, a crisis comes. Additionally, I show that government prefers to be less transparent when it is more
likely to have better times; and commits to disclose fully its state when it expects more
likely to have bad times. If the probability of an upcoming crisis is very high, uninformed
lenders increase the costs of borrowing. As a result, the optimal amount of debt under null
transparency is close to the level that government in a crisis can borrow even if it reveals its
state. Hence, government prefers to be fully transparent and enjoy higher consumption if it
ends up in a good state during high probability of a crisis. If a recession is less likely, the
price o ered by lenders increases, the amount of debt that a non-transparent government
can borrow is higher and as a result, bene ts from being opaque also rise.
Chapter 4 suggest some potential areas for future research.
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Keywords
Deuda publica, Información económica, Incertidumbre