| Summary: | This thesis examines the issue of political versus economic incentives to default, with regard to the present Greece debt crisis. It is hypothesized that when a country has strong political incentives to not default on its debt it will choose not to do so, despite such a course being advantageous according to economic rationale. To assess this issue, a sovereign default model is calibrated to match the economy of Greece. The model mimics the core movements of the data quite well, with exception of spreads and debt-to-output-ratio, and it predicts a default for Greece every 312.5 years. The sensitivity analysis illuminates a high sensitivity to the assumption of a highly patient borrower, resulting in low spreads and a low debt-to-output ratio. Since the early thirties no Western European country has defaulted on its debt. It has been regarded as a rather remote phenomenon occurring in distant developing countries, or in socialist/post-socialist republics.1 This track record has however been challenged in the aftermath of the financial crisis erupting in 2007, starting with socialisation of several banks in various countries. The most extreme example of a bank bailout had been in Iceland, which has been subject to speculations as to whether or not the country will default on at least parts of its debt. Iceland has been followed by a debt crisis in several EMU countries, most notably Greece, Spain and Portugal. The economic crisis, and potential implications for EMU countries, has spilled over from being a purely economic matter to also encompass a political crisis. Despite several bailouts from the other member countries and the IMF, the Greek crisis still lingers on. The need for a Greek haircut and political reforms within the EU, in order to avoid a Greek default, seems to become even more urgent by the day.2 One might thus ask whether or not Greece should already have defaulted on her debt, instead of continuing to service it and implement austerity packages rendering social unrest. There must certainly be ...
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