TY - JOUR AU - Broner,Fernando AU - Martin,Alberto AU - Ventura,Jaume TI - Sovereign Risk and Secondary Markets JF - National Bureau of Economic Research Working Paper Series VL - No. 12783 PY - 2006 Y2 - December 2006 UR - http://www.nber.org/papers/w12783 L1 - http://www.nber.org/papers/w12783.pdf N1 - Author contact info: Fernando Broner CREI and Universitat Pompeu Fabra Ramon Trias Fargas, 25-27 08005 Barcelona Spain Tel: +34-935422601 Fax: +34-935421860 E-Mail: fbroner@crei.cat Alberto Martin CREI Universitat Pompeu Fabra Ramon Trias Fargas, 25-27 08005 Barcelona Spain E-Mail: amartin@crei.cat Jaume Ventura CREI Universitat Pompeu Fabra Ramon Trias Fargas, 25-27 08005-Barcelona SPAIN Tel: +34 93 542 1765 Fax: +34 93 542 1860 E-Mail: jventura@crei.cat AB - Conventional wisdom says that, in the absence of sufficient default penalties, sovereign risk constrains credit and lowers welfare. We show that this conventional wisdom rests on one implicit assumption: that assets cannot be retraded in secondary markets. Once this assumption is relaxed, there is always an equilibrium in which sovereign risk is stripped of its conventional effects. In such an equilibrium, foreigners hold domestic debts and resell them to domestic residents before enforcement. In the presence of (even arbitrarily small) default penalties, this equilibrium is shown to be unique. As a result, sovereign risk neither constrains welfare nor lowers credit. At most, it creates some additional trade in secondary markets. The results presented here suggest a change in perspective regarding the origins of sovereign risk and its remedies. To argue that sovereign risk constrains credit, one must show both the insufficiency of default penalties and the imperfect workings of secondary markets. To relax credit constraints created by sovereign risk, one can either increase default penalties or improve the workings of secondary markets. ER -