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Sovereign Default and Liquidity: The Case for a World Safe Asset

Abstract : This paper presents a positive and normative study of a world financial market when sovereign countries can default on their debt. We construct a tractable model that enables us to study sovereign default in general equilibrium. The amount of safe assets is thus endogenous and determined by international risk-sharing. We characterize the equilibrium structure and we show that the market equilibrium can generate multiple equilibria. In addition, the market equilibrium is not constrained-efficient because countries do not fully internalize the value of their debt being used as liquidity. We prove that a world fund issuing a safe asset increases aggregate welfare. The fund's relationship with the IMF's Special Drawing Rights is discussed.
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Submitted on : Thursday, December 30, 2021 - 1:59:18 PM
Last modification on : Thursday, December 1, 2022 - 6:16:28 AM


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François Le Grand, Xavier Ragot. Sovereign Default and Liquidity: The Case for a World Safe Asset. Journal of International Economics, 2021, 131, pp.103462. ⟨10.1016/j.jinteco.2021.103462⟩. ⟨hal-03501397⟩



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