European Parliament Library

Quantitative properties of sovereign default models :, solution methods matter, Leonardo Martinez, Horacio Sapriza, Juan Carlos Hatchondo

Abstract
We study the sovereign default model that has been used to account for the cyclical behavior of interest rates in emerging market economies. This model is often solved using the discrete state space technique with evenly spaced grid points. We show that this method necessitates a large number of grid points to avoid generating spurious interest rate movements. This makes the discrete state technique significantly more inefficient than using Chebyshev polynomials or cubic spline interpolation to approximate the value functions. We show that the inefficiency of the discrete state space technique is more severe for parameterizations that feature a high sensitivity of the bond price to the borrowing level for the borrowing levels that are observed more frequently in the simulations. In addition, we find that the efficiency of the discrete state space technique can be greatly improved by (i) finding the equilibrium as the limit of the equilibrium of the finite-horizon version of the model, instead of iterating separately on the value and bond price functions and (ii) concentrating grid points in asset levels at which the bond price is more sensitive to the borrowing level and in levels that are observed more often in the model simulations. Our analysis questions the robustness of results in the sovereign default literature and is also relevant for the study of other credit markets
Table Of Contents
Cover Page; Title Page; Copyright Page; Contents; I. Introduction; II. The model; III. Parameterization; 1. Parameter values; IV. Computation; 2. Grid specifications; V. Results; A. One-loop and two-loop algorithms; B. Simulations; 3. Simulation results and computation time; C. The width of the endowment grid; 1. Optimal savings for DSS endowment grids of different width; D. The number of endowment grid points; 4. Model III simulation results; 2. Imprecisions caused by using coarse grids for endowment levels; E. The number of asset grid points
Language
eng
Literary Form
non fiction
Note
Description based upon print version of record
Physical Description
1 online resource (45 p.)
Specific Material Designation
remote
Form Of Item
online
Isbn
9781462347674

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