Last updated: June 2006
Volume 53, Number 2
IMF Staff Papers

Volatility and the Debt-Intolerance Paradox

Luis Catão and Sandeep Kapur

Full Text of this Article (PDF 196K)

Abstract: A striking feature of sovereign lending is that many countries with moderate debtto-income ratios systematically face higher spreads and more stringent borrowing constraints than other countries with far higher debt ratios. Earlier research has rationalized the phenomenon in terms of sovereign reputation and countries' distinct credit histories. This paper provides theoretical and empirical evidence to show that differences in underlying macroeconomic volatility are key. While volatility increases the need for international borrowing to help smooth domestic consumption, the ability to borrow is constrained by the higher default risk that volatility engenders. [JEL C23, F34]