Working Paper: CEPR ID: DP10322
Authors: Raquel Fernández; Alberto Martin
Abstract: We present a simple model of sovereign debt crises in which a country chooses its optimal mix of short and long-term bonds subject to standard contracting frictions: the country cannot commit to repay its debts nor to a specific path of future debt issues, and contracts cannot be made state contingent nor renegotiated. We show that, in order to reduce incentives to engage in debt dilution, the country must issue short-term debt. This exposes it to roll-over crises and inefficient repayments. We examine the effects of alternative restructuring regimes, which either write-down debt or extend its maturity in the event of crises, and show that both necessarily improve ex ante welfare if they they do not decrease expected payments to creditors during crises. In particular, we show that the way in which these regimes redistribute payments between short- and long-term creditors, which has been a central point in recent policy debates, is inconsequential.
Keywords: dilution; IMF; optimal maturity; reprofiling; restructuring; sovereign debt
JEL Codes: F33; F34; F36; F41; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| short-term debt (H63) | reduce incentives for debt dilution (G32) |
| reduce incentives for debt dilution (G32) | exposes it to rollover crises (F65) |
| restructuring regimes (P21) | enhance ex post efficiency (D61) |
| restructuring regimes (P21) | decrease total net present value of resources shared (H43) |
| restructuring regimes (P21) | improve ex ante welfare (D69) |
| distribution of payments among creditors (G33) | total payments to creditors during crises (G01) |