Working Paper: NBER ID: w22847
Authors: Mark Aguiar; Manuel Amador; Hugo Hopenhayn; Ivan Werning
Abstract: We study the interactions between sovereign debt default and maturity choice in a setting with limited commitment for repayment as well as future debt issuances. Our main finding is that under a wide range of conditions the sovereign should, as long as default is not preferable, remain passive in long-term bond markets, making payments and retiring long-term bonds as they mature but never actively issuing or buying back such bonds. The only active debt-management margin is the short-term bond market. We show that any attempt to manipulate the existing maturity profile of outstanding long-term bonds generates losses, as bond prices move against the sovereign. Our results hold regardless of the shape of the yield curve. The yield curve captures the average costs of financing at different maturities but is misleading regarding the marginal costs.
Keywords: Sovereign debt; Default; Debt maturity; Fiscal policy
JEL Codes: E62; F34; F41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| The decision not to engage in long-term bond markets (G19) | maximization of the sovereign's budget set (D10) |
| Refraining from issuing or repurchasing long-term bonds (H74) | reduces future default risk (G33) |
| The maturity profile of debt (G32) | influences future default probabilities (G33) |
| Short-term debt issuance (H63) | incentivizes fiscal trajectories that reduce default risk (E62) |
| Engaging with long-term debt (G32) | leads to losses due to adverse price movements in bond markets (G10) |
| Altering the existing maturity profile of debt (G32) | results in losses (G33) |