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Debt dilution and seniority in a model of defaultable sovereign debt

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  • Satyajit Chatterjee
  • Burcu Eyigungor

Abstract

An important ineffciency in sovereign debt markets is debt dilution, wherein sovereigns ignore the adverse impact of new debt on the value of existing debt and, consequently, borrow too much and default too frequently. A widely proposed remedy is the inclusion of seniority clause in sovereign debt contracts: Creditors who lent first have priority in any restructuring proceedings. We incorporate seniority in a quantitatively realistic model of sovereign debt and find that seniority is quite effective in mitigating the dilution problem. We also show theoretically that seniority cannot be fully effective unless the costs of debt restructuring are zero.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 13-30.

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Date of creation: 2013
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Handle: RePEc:fip:fedpwp:13-30

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Keywords: Debt;

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  1. Hatchondo, Juan Carlos & Martinez, Leonardo, 2009. "Long-duration bonds and sovereign defaults," Journal of International Economics, Elsevier, vol. 79(1), pages 117-125, September.
  2. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  3. Pablo A. Neumeyer & Fabrizio Perri, 2004. "Business Cycles in Emerging Economies: The Role of Interest Rates," NBER Working Papers 10387, National Bureau of Economic Research, Inc.
  4. Satyajit Chatterjee & Burcu Eyigungor, 2009. "Maturity, Indebtedness, and Default Risk," Koç University-TUSIAD Economic Research Forum Working Papers, Koc University-TUSIAD Economic Research Forum 0901, Koc University-TUSIAD Economic Research Forum.
  5. Aguiar, Mark & Gopinath, Gita, 2006. "Defaultable debt, interest rates and the current account," Journal of International Economics, Elsevier, vol. 69(1), pages 64-83, June.
  6. Leonardo Martinez & Cesar Sosa Padilla & Juan Hatchondo, 2012. "Debt dilution and sovereign default risk," 2012 Meeting Papers, Society for Economic Dynamics 974, Society for Economic Dynamics.
  7. Cristina Arellano & Ananth Ramanarayanan, 2008. "Default and the maturity structure in sovereign bonds," Globalization and Monetary Policy Institute Working Paper 19, Federal Reserve Bank of Dallas.
  8. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
  9. Jeffrey Sachs & Daniel Cohen, 1982. "LDC Borrowing with Default Risk," NBER Working Papers 0925, National Bureau of Economic Research, Inc.
  10. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
  11. Diego Saravia, 2004. "On the Role and E ects of IMF Seniority," Econometric Society 2004 Latin American Meetings, Econometric Society 131, Econometric Society.
  12. Eduardo Borensztein & Olivier Jeanne & Paolo Mauro & Jeromin Zettelmeyer & Marcos Chamon, 2005. "Sovereign Debt Structure for Crisis Prevention," IMF Occasional Papers 237, International Monetary Fund.
  13. Michael P. Dooley, 2000. "Can Output Losses Following International Financial Crises be Avoided?," NBER Working Papers 7531, National Bureau of Economic Research, Inc.
  14. Cole, Harold L. & Kehoe, Timothy J., 1996. "A self-fulfilling model of Mexico's 1994-1995 debt crisis," Journal of International Economics, Elsevier, vol. 41(3-4), pages 309-330, November.
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Blog mentions

As found by EconAcademics.org, the blog aggregator for Economics research:
  1. Avoiding sovereign debt dilution with debt seniority
    by Economic Logician in Economic Logic on 2012-07-10 14:04:00
  2. [経済]ソブリン危機を避ける一法
    by himaginary in himaginaryの日記 on 2012-07-12 07:00:00
  3. A solution to sovereign debt dilution
    by Economic Logician in Economic Logic, Too on 2014-01-20 17:40:00

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