Papers

"The Role of International Reserves in Sovereign Debt Restructuring under Fiscal Adjustment", 2018, Tiago Tavares [submitted]
Current Version [Link]; Abstract []


Abstract:
Highly indebted developing economies commonly also hold large external reserves. This behavior seems puzzling given that governments in these countries borrow with an interest rate penalty to compensate lenders for default risk. Reducing debt to the same extent as reserves would maintain net liabilities constant while decreasing interest payments. However, holding reserves can have insurance benefits in a financial crisis. To rationalize the levels of international reserves and external debt observed in the data, a standard dynamic model of equilibrium default is extended to include distortionary taxation and debt restructuring. This paper shows that fiscal adjustments induced by sovereign default can generate large demand for reserves if taxation is distortionary. At the same time, a non-negligible position in reserves modifies the debt restructuring negotiations upon default. A calibrated version of the model produces recovery rate schedules that are increasing with reserves, as seen in the data, being also able to replicate large positions of reserves and debt to GDP. Finally, I study how both mechanisms play a key quantitative role to generate such result, in fact, not including them, produces a counterfactual demand for reserves that is close to zero.



"Labor Market Distortions under International Financial Crisis", 2018, Tiago Tavares [submitted]
Current Version [Link]; Abstract []


Abstract:
Risk of sovereign debt default has frequently affected emerging market and developed economies. Such financial crisis are often accompanied with severe declines of employment that are hard to justify using a standard dynamic stochastic model. In this paper, I document that a labor wedge deteriorates substantially around swift reversals of current accounts or default episodes. I propose and evaluate two different explanations for these movements by linking the wedges to changes in labor taxes and in the cost of working capital. With these two features included, a dynamic model of equilibrium default is able to replicate the behavior of the labor wedge observed in the data around financial crisis. In the model, higher interest rates are propagated into larger costs of hiring labor through the presence of working capital. As an economy is hit with a stream of bad productivity shocks, the incentives to default become stronger, thus increasing the cost of debt. This reduces firm demand for labor and generates a labor wedge. A similar effect is obtained with a counter-cyclical tax rate policy. The model is used to shed light on the recent events of the Euro Area debt crisis and in particular of the Greek default event.



"Investment Slumps during Financial Crises: The Role of Credit Constraints", 2018, Tiago Tavares joint with Alexandros Fakos and Plutarchos Sakellaris [submitted]
Current Version [Link]; Abstract []


Abstract:
How much do credit constraints contribute to investment slumps during financial crises? For the Greek crisis that erupted in 2010, we find that tightened credit constraints contributed to about half of the observed collapse in investment rates. The remainder is explained by diminished demand and productivity facing the firms. We use a novel census-type dataset of manufacturing firms and show that standard dynamic investment models abstracting from credit constraints cannot reproduce the observed investment dynamics. Enhanced with borrowing constraints subject to an aggregate shock to eligible collateral, such models can account for the observed collapse in investment rates.



"Heterogeneous Investment Dynamics of Greek Manufacturing Firms", 2017, Tiago Tavares joint with Alexandros Fakos [under revision]
Current Version [Link]; Abstract []


Abstract:
In this paper we study firm-level investment dynamics by incorporating an idiosyncratic investment cost shock in a dynamic investment model of heterogeneous firms with adjustment costs. We interpret this idiosyncratic shock as an investment wedge summarizing firm deviations from model implied efficient behavior. We estimate our dynamic model using data micro-level data of Greek manufacturing firms, allowing for firms to be heterogenous in both profitability and investment cost. Our estimation results show that the level of dispersion of the idiosyncratic investment shock is of the same order of magnitude as the profitability shock which tends to be substantial in most micro-studies. We also find evidence that the investment wedge is correlated with variables not explicitly taken into account by our model such as measures of firm-level leverage and export intensity. This suggests that a financial channel in models of capital accumulation may be crucial in explaining data patterns.



"Noisy information About the Trend and Sovereign Default Risk", 2015, Tiago Tavares [under revision]
Current Version [Link - soon]; Abstract []


Abstract:
Emerging markets economies are subject to substantial volatility in trend growth motivated by frequent policy reversals. Also, agents in emerging markets face higher uncertainty due to weak institutions and political instability. Motivated by these observations, we build a dynamic stochastic model in which agents cannot perfectly distinguish between the trend and transient component of observed endowments, but can only learn about them by solving a signal-extraction problem. We extend this model to include endogenous default risk and conclude that, for similar endowment and debt levels, higher uncertainty about the trend implies larger default risk. This result is consistent with the documented empirical observation that interest rate spreads are, on average, larger in periods that surround election periods, associated with higher uncertainty, as well with other empirical regularities regarding emerging markets. Furthermore, we use the model to shed light on the recent events that characterized the greek sovereign debt crisis.