Globalization and International Public Finance, Issue 7575
National Bureau of Economic Research, 2000 - Capital market - 27 pages
This paper examines the effect of reduced transaction costs in the international trading of assets on the ability of governments to issue debt. We examine a model in which governments care about the welfare of their citizens, and thus are more inclined to default if a large proportion of their debt is held by foreigners. Reductions in transaction costs make it easier for domestic citizens to share risk by selling debt to foreigners. This may increase tendencies for governments to default, and thus raise their cost of credit and reduce welfare. We find that even in the absence of transaction costs, home bias in placement of government debt may persist, because in the presence of default risk the return on government debt is correlated with the tax burden required to pay the debt. Asset inequality may reduce this home bias, and by increasing foreign ownership, increase incentives for default. Finally, if foreign creditors are less risk averse than domestic creditors, there may be one equilibrium in which domestic creditors hold the asset and default risk is low, and another in which foreign creditors hold the asset and default risk is high
What people are saying - Write a review
We haven't found any reviews in the usual places.
aggregate amount of debt certainty equivalent commit to repay cost of inflation creditors will hold debt denominated debt is held default risk denominated debt denominated in domestic denominated in foreign disfavored creditors domestic agents domestic and foreign domestic creditors domestic currency domestic residents Economics equilibrium price Finance foreign creditors foreign currency Goetzmann government debt held government's inflation decision government's terms held by domestic held by foreigners held domestically hence home bias inflationary erosion investment issue debt less risk averse Luigi Zingales Mark Gertler Michael Kremer Monetary Policy multiple equilibria NBER Working Paper normally distributed optimal partial equilibrium place its debt portfolio decision price of debt price of government probability of default rational expectations real return reduced transaction costs reduction in transaction repudiation return on government risk neutral safe asset second period Section sovereign debt target inflation terms of credit trade unit of debt unit of wealth worsen the government's