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Renegotiation Policies in Sovereign Defaults

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Author Info

  • Arellano, Cristina

    (Federal Reserve Bank of Minneapolis)

  • Bai, Yan

    (University of Rochester)

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    Abstract

    This paper studies an optimal renegotiation protocol designed by a benevolent planner when two countries renegotiate with the same lender. The solution calls for recoveries that induce each country to default or repay, trading off the deadweight costs and the redistribution benefits of default independently of the other country. This outcome contrasts with a decentralized bargaining solution where default in one country increases the likelihood of default in the second country because recoveries are lower when both countries renegotiate. The paper suggests that policies geared at designing renegotiation processes that treat countries in isolation can prevent contagion of debt crises.

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    Bibliographic Info

    Paper provided by Federal Reserve Bank of Minneapolis in its series Staff Report with number 495.

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    Length: 16 pages
    Date of creation: 10 Jan 2014
    Date of revision:
    Handle: RePEc:fip:fedmsr:495

    Note: Forthcoming In: American Economic Review Papers and Proceedings
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    Related research

    Keywords: Renegotiation policy; Contagion; Sovereign default;

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    References

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    1. Pablo D'Erasmo & Enrique G. Mendoza, 2013. "Distributional Incentives in an Equilibrium Model of Domestic Sovereign Default," NBER Working Papers 19477, National Bureau of Economic Research, Inc.
    2. Paolo Angelini & Stefano Neri & Fabio Panetta, 2011. "Monetary and macroprudential policies," Temi di discussione (Economic working papers) 801, Bank of Italy, Economic Research and International Relations Area.
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