Rare Disasters, Financial Development, and Sovereign Debt
We propose a model of sovereign debt where countries vary in their level of financial development, defined as the extent to which countries can hedge rare disasters in international capital markets. We show that low levels of financial development generate the “debt intolerance” phenomenon that plagues emerging markets: it reduces debt capacity, increases credit spreads, and limits the ability to smooth consumption.
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Document Object Identifier (DOI): 10.3386/w25031