When a country's debt doubles, it's mathematically 'smarter' to default, but leaders keep paying in a desperate gamble to be saved.
Using Senegal's 2024 hidden debt revelation as a case study, researchers found that while models predicted default was the rational move, governments often choose to continue repayment under fragile conditions because they are betting on a future economic miracle to save them.
Hidden Debt Revelation and Optimal Default
SSRN · 6456639
Hidden public liabilities are a pervasive but poorly measured feature of sovereign balance sheets. When they are eventually revealed, they can reprice sovereign risk overnight and compress the policy space between painful fiscal adjustment and default. This paper studies optimal sovereign default following the revelation of hidden debt. We develop a quantitative model of optimal sovereign default following a hidden-debt revelation and apply it to Senegal's 2024 shock, in which an incoming admini