Working Paper: CEPR ID: DP6249
Authors: Fernando A. Broner; Guido Lorenzoni; Sergio Schmukler
Abstract: We argue that emerging economies borrow short term due to the high risk premium charged by bondholders on long-term debt. First, we present a model where the debt maturity structure is the outcome of a risk sharing problem between the government and bondholders. By issuing long-term debt, the government lowers the probability of a rollover crisis, transferring risk to bondholders. In equilibrium, this risk is reflected in a higher risk premium and borrowing cost. Therefore, the government faces a trade-off between safer long-term debt and cheaper short-term debt. Second, we construct a new database of sovereign bond prices and issuance. We show that emerging economies pay a positive term premium (a higher risk premium on long-term bonds than on short-term bonds). During crises, the term premium increases, with issuance shifting towards shorter maturities. The evidence suggests that international investors' time-varying risk aversion is crucial to understand the debt structure in emerging economies.
Keywords: emerging market debt; financial crises; investor risk aversion; maturity structure; risk premium; term premium
JEL Codes: E43; F30; F32; F34; F36; G15
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Higher risk premiums on long-term bonds (E43) | Preference for short-term borrowing (G21) |
| Choice of debt maturity (G32) | Risk of rollover crises (G01) |
| Heightened investor risk aversion during crises (G01) | Preference for short-term debt (G19) |
| Changes in investor sentiment (G41) | Borrowing patterns (G51) |