Abstract: In this paper, we develop a small open economy model to study debt
renegotiation and sovereign default within a dynamic borrowing framework. The
model features both endogenous default risk and endogenous debt recovery rates.
Sovereign bonds are priced to compensate creditors for the risks of default and
debt restructuring in equilibrium. We find that both equilibrium debt recovery
rates and sovereign bond prices decrease with the level of debt. In a
quantitative analysis, the model successfully accounts for the volatile and
countercyclical bond spreads, countercyclical current account and other
empirical regularities of the Argentine economy. The model also replicates the
dynamics of bond spreads during the recent debt crisis in