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Default and the maturity structure in sovereign bonds

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  • Cristina Arellano
  • Ananth Ramanarayanan

Abstract

This paper studies the maturity composition and the term structure of interest rate spreads of government debt in emerging markets. In the data, when interest rate spreads rise, debt maturity shortens and the spread on short-term bonds is higher than on long-term bonds. To account for this pattern, we build a dynamic model of international borrowing with endogenous default and multiple maturities of debt. Short-term debt can deliver higher immediate consumption than long-term debt; large long-term loans are not available because the borrower cannot commit to save in the near future towards repayment in the far future. However, issuing long-term debt can insure against the need to roll-over short-term debt at high interest rate spreads. The trade-off between these two benefits is quantitatively important for understanding the maturity composition in emerging markets. When calibrated to data from Brazil, the model matches the dynamics in the maturity of debt issuances and its comovement with the level of spreads across maturities.

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Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 410.

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Date of creation: 2008
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Handle: RePEc:fip:fedmsr:410

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Keywords: Bonds ; Debt ; Default (Finance);

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References

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  1. Mark Aguiar & Gita Gopinath, 2004. "Defaultable Debt, Interest Rates and the Current Account," NBER Working Papers 10731, National Bureau of Economic Research, Inc.
  2. Hatchondo, Juan Carlos & Martinez, Leonardo, 2009. "Long-duration bonds and sovereign defaults," Journal of International Economics, Elsevier, vol. 79(1), pages 117-125, September.
  3. Cristina Arellano & Yan Bai & Jing Zhang, 2009. "Firm Dynamics and Financial Development," NBER Working Papers 15193, National Bureau of Economic Research, Inc.
  4. Diamond, Douglas W, 1991. "Debt Maturity Structure and Liquidity Risk," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 709-37, August.
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  10. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-70, May.
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  12. Thomas F. Cooley & Vincenzo Quadrini, 1999. "Financial Markets and Firm Dynamics," Working Papers 99-14, New York University, Leonard N. Stern School of Business, Department of Economics.
  13. Harold L. Cole & Timothy J. Kehoe, 1996. "A self-fulfilling model of Mexico's 1994-95 debt crisis," Staff Report 210, Federal Reserve Bank of Minneapolis.
  14. Fernando Broner & Guido Lorenzoni & Sergio Schmuckler, 2006. "Why Do Emerging Economies Borrow Short Term?," 2006 Meeting Papers 841, Society for Economic Dynamics.
  15. Pablo Andres Neumeyer & Fabrizio Perri, 1999. "Business Cycles in Emerging Economies: the role of interest rates," Department of Economics Working Papers 014, Universidad Torcuato Di Tella.
  16. Refet S. Gürkaynak & Brian Sack & Jonathan H. Wright, 2006. "The U.S. Treasury yield curve: 1961 to the present," Finance and Economics Discussion Series 2006-28, Board of Governors of the Federal Reserve System (U.S.).
  17. Buera, Francisco & Nicolini, Juan Pablo, 2004. "Optimal maturity of government debt without state contingent bonds," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 531-554, April.
  18. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
  19. George-Marios Angeletos, 2002. "Fiscal Policy With Noncontingent Debt And The Optimal Maturity Structure," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 1105-1131, August.
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Citations

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Cited by:
  1. Niepelt, Dirk, 2008. "Debt Maturity without Commitment," CEPR Discussion Papers 7093, C.E.P.R. Discussion Papers.
  2. Satyajit Chatterjee & Burcu Eyigungor, 2010. "Maturity, indebtedness, and default risk," Working Papers 10-12, Federal Reserve Bank of Philadelphia.
  3. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2009. "On the cyclicality of the interest rate in emerging economy models: solution methods matter," Working Paper 09-13, Federal Reserve Bank of Richmond.
  4. Leonardo Martinez & Juan Carlos Hatchondo & Cesar Sosa Padilla, 2011. "Debt Dilution and Sovereign Default Risk," IMF Working Papers 11/70, International Monetary Fund.
  5. Fabian Fink & Almuth Scholl, 2011. "A Quantitative Model of Sovereign Debt, Bailouts and Conditionality," Working Paper Series of the Department of Economics, University of Konstanz 2011-46, Department of Economics, University of Konstanz.
  6. Daniel A. Dias & Christine J. Richmond & Mark L.J. Wright, 2011. "The Stock of External Sovereign Debt: Can We Take the Data At ‘Face Value’?," NBER Working Papers 17551, National Bureau of Economic Research, Inc.
  7. Lizarazo, Sandra, 2009. "Contagion of Financial Crises in Sovereign Debt Markets," MPRA Paper 20795, University Library of Munich, Germany, revised 06 Feb 2010.
  8. Zhu, Junjun & Xie, Shiyu, 2011. "Asymmetric Shocks, Long-term Bonds and Sovereign Default," MPRA Paper 28236, University Library of Munich, Germany.

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