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Abstract
AbstractWe develop a model that features costly market segmentation and financial repression to link domestic and external sovereign debt with default. In a financially repressed economy, a government that exploits its market power in the domestic economy can also increase its external debt capacity, owing to a novel, additional endogenous cost of default. A government forfeits the gains from trading in segmented debt markets when it defaults. Among other empirical regularities, our model can account for the heterogeneity in sovereign debt levels of nonadvanced economies, based on their level of financial development.
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