Working Paper: CEPR ID: DP312
Authors: Daniel Cohen
Abstract: This paper analyzes the inefficiency that arises from a debt overhang. In order to define the lenders' optimal rescheduling strategy, I calculate the maximum present discounted value of the repayment they could obtain. This upper bound occurs when the borrower gives up sovereignty over all decisions except to default. To secure the maximum, however, the lenders do not simply extract a payment equal to the cost of default, but allows the country to invest more. The maximum present discounted value return coincides with the equilibrium market value of the debt. Rather than a debt write-off, the key to an efficient rescheduling process is a clear commitment from the lenders that the flow of resources they will ask the debtor to transfer will reflect the secondary market discou.
Keywords: LDC debt; secondary market discount; buybacks
JEL Codes: 430
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| debt overhang (H63) | decreased investment returns (G11) |
| increasing debt (H63) | decreased investment returns (G11) |
| lender behavior (G21) | borrower investment (G51) |
| debt service adjustment based on market value (F34) | encourage investment (F21) |
| debt write-off (G33) | address core inefficiencies (D61) |