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Are buybacks back? Menu-driven debt reduction schemes with heterogeneous creditors

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  • Diwan, Ishac
  • Spiegel, Mark M.

Abstract

There is always some price that is low enough so that a debtor country gains by buying back some of its debts. Similarly, there is always some price that is high enough so that creditors gain by selling their debt claims. What is needed is a mechanism that allows trades to take place at some price within this range. One mechanism, the market buyback, has been called a boondoggle. However, market buybacks are too expensive from the debtor's point of view and faced with a buyback bid, each creditor has incentives to hold onto its claim unless the bid is larger than the value of debt after the deal. Concerted debt-reduction agreements can overcome this type of coordination failure, but they may be difficult to reach in practice because of the heterogeneity of creditors. The authors argue that the menu approach to debt reduction retains the advantages but not the inconvenience of buybacks and concerted agreements. They introduce a model of bank asset pricing in the presence of tax incentives and deposit insurance. They then derive the equilibrium level of exit and new money for a distributionof creditors facing a given menu program. They show that the optimal menu includes some positive level of debt repurchase in almost all cases - challenging the argument that buybacks are undesirable. The authors conclude that the menu program dominates the standard buyback and new money approaches.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Monetary Economics.

Volume (Year): 34 (1994)
Issue (Month): 2 (October)
Pages: 279-293

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Handle: RePEc:eee:moneco:v:34:y:1994:i:2:p:279-293

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Web page: http://www.elsevier.com/locate/inca/505566

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References

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  1. Merton, Robert C., 1977. "An analytic derivation of the cost of deposit insurance and loan guarantees An application of modern option pricing theory," Journal of Banking & Finance, Elsevier, vol. 1(1), pages 3-11, June.
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Cited by:
  1. Mark M. Spiegel, 1996. "Fixed-premium deposit insurance and international credit crunches," Economic Review, Federal Reserve Bank of San Francisco, pages 3-15.
  2. Prokop, Jacek, 1995. "Organized debt buybacks: No cure for free riding?," Journal of Development Economics, Elsevier, vol. 47(2), pages 481-496, August.
  3. Hayri, Aydin, 1997. "Debt Relief," CEPR Discussion Papers 1701, C.E.P.R. Discussion Papers.
  4. Fernando Broner & Alberto Martin & Jaume Ventura, 2006. "Sovereign Risk and Secondary Markets," 2006 Meeting Papers 565, Society for Economic Dynamics.
  5. Eaton, Jonathan & Fernandez, Raquel, 1995. "Sovereign debt," Handbook of International Economics, in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 3, pages 2031-2077 Elsevier.
  6. Demirguc-Kunt, Ash & Diwan, Ishac & Spiegel, Mark M., 1997. "Heterogeneity in bank valuation of LDC debt: Evidence from the 1988 Brazilian debt-reduction program," Journal of Monetary Economics, Elsevier, vol. 39(3), pages 535-550, August.
  7. Prokop, Jacek, 2012. "Bargaining over debt rescheduling," MPRA Paper 44315, University Library of Munich, Germany.
  8. Bowe, M. & Dean, J.W., 1997. "Has the Market Solved the Sovereign-Debt Crisis?," Princeton Studies in International Economics 83, International Economics Section, Departement of Economics Princeton University,.

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