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Voluntary Sovereign Debt Exchanges

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  • Juan Carlos Hatchondo
  • Leonardo Martinez
  • Cesar Sosa Padilla

Abstract

We show that some recent sovereign debt restructurings were characterized by (i) the absence of missed debt payments prior to the restructurings, (ii) reductions in the government’s debt burden, and (iii) increases in the market value of debt claims for holders of the restructured debt. Since both the government and its creditors are likely to benefit from such restructurings, we label these episodes as “voluntary” debt exchanges. We present a model in which voluntary debt exchanges can occur in equilibrium when the debt level takes values above the one that maximizes the market value of debt claims. In contrast to previous studies on debt overhang, in our model opportunities for voluntary exchanges arise because a debt reduction implies a decline of sovereign default risk. This is observed in the absence of any effect of debt reductions on future output levels. Although voluntary exchanges are Pareto improving at the time of the restructuring, we show that eliminating the possibility of conducting voluntary exchanges may improve welfare from an ex-ante perspective. Thus, our results highlight a cost of initiatives that facilitate debt restructurings.

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Bibliographic Info

Paper provided by McMaster University in its series Department of Economics Working Papers with number 2013-13.

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Length: 37 pages
Date of creation: Aug 2013
Date of revision:
Handle: RePEc:mcm:deptwp:2013-13

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Keywords: Sovereign Default; Debt Restructuring; Voluntary Debt Exchanges; Long-term Debt; Endogenous Borrowing Constraints.;

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References

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  1. Juan Carlos Hatchondo & Leonardo Martinez, 2013. "Sudden stops, time inconsistency, and the duration of sovereign debt," Working Paper, Federal Reserve Bank of Richmond 13-08, Federal Reserve Bank of Richmond.
  2. Paul R. Krugman, 1988. "Market-Based Debt-Reduction Schemes," NBER Working Papers 2587, National Bureau of Economic Research, Inc.
  3. Uribe, Martin & Yue, Vivian Z., 2006. "Country spreads and emerging countries: Who drives whom?," Journal of International Economics, Elsevier, Elsevier, vol. 69(1), pages 6-36, June.
  4. Juan Carlos Hatchondo & Leonardo Martinez, 2009. "Long-duration bonds and sovereign defaults," Working Paper, Federal Reserve Bank of Richmond 08-02, Federal Reserve Bank of Richmond.
  5. Aguiar, Mark & Gopinath, Gita, 2007. "Emerging Market Business Cycles: The Cycle is the Trend," Scholarly Articles 11988098, Harvard University Department of Economics.
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  7. Cruces, Juan J. & Trebesch, Christoph, 2013. "Sovereign defaults: The price of haircuts," Munich Reprints in Economics, University of Munich, Department of Economics 20036, University of Munich, Department of Economics.
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  9. Jeromin Zettelmeyer & Federico Sturzenegger, 2005. "Haircuts," IMF Working Papers, International Monetary Fund 05/137, International Monetary Fund.
  10. 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.
  11. Enderlein, Henrik & Trebesch, Christoph & Daniels, Laura von, 2012. "Sovereign debt disputes: A database on government coerciveness during debt crises," Munich Reprints in Economics, University of Munich, Department of Economics 20555, University of Munich, Department of Economics.
  12. Vivian Z. Yue & Enrique G. Mendoza, 2011. "A General Equilibrium Model of Sovereign Default and Business Cycles," IMF Working Papers, International Monetary Fund 11/166, International Monetary Fund.
  13. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, American Economic Association, vol. 98(3), pages 690-712, June.
  14. Mark Aguiar & Gita Gopinath, 2007. "Emerging Market Business Cycles: The Cycle Is the Trend," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 115, pages 69-102.
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  17. Javier Díaz-Cassou & Aitor Erce-Domínguez & Juan J. Vázquez-Zamora, 2008. "Recent episodes of sovereign debt restructurings. A case-study approach," Banco de Espa�a Occasional Papers, Banco de Espa�a 0804, Banco de Espa�a.
  18. Juan Carlos Hatchondo & Francisco Roch & Leonardo Martinez, 2012. "Fiscal Rules and the Sovereign Default Premium," IMF Working Papers, International Monetary Fund 12/30, International Monetary Fund.
  19. 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.
  20. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2010. "Online Appendix to "Quantitative properties of sovereign default models: solution methods"," Technical Appendices, Review of Economic Dynamics 08-133, Review of Economic Dynamics.
  21. Juan Jose Cruces & Marcos Buscaglia & Joaquin Alonso, 2002. "The Term Structure of Country Risk and Valuation in Emerging Markets," Working Papers, Universidad de San Andres, Departamento de Economia 46, Universidad de San Andres, Departamento de Economia, revised Apr 2002.
  22. Yue, Vivian Z., 2010. "Sovereign default and debt renegotiation," Journal of International Economics, Elsevier, Elsevier, vol. 80(2), pages 176-187, March.
  23. Froot, Kenneth A, 1989. "Buybacks, Exit Bonds, and the Optimality of Debt and Liquidity Relief," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 30(1), pages 49-70, February.
  24. Paul R. Krugman, 1988. "Financing vs. Forgiving a Debt Overhang," NBER Working Papers 2486, National Bureau of Economic Research, Inc.
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  26. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers, Society for Economic Dynamics 531, Society for Economic Dynamics.
  27. Juan Carlos Hatchondo & Leonardo Martinez, 2011. "Legal protection to foreign investors," Economic Quarterly, Federal Reserve Bank of Richmond, Federal Reserve Bank of Richmond, issue 2Q, pages 175-187.
  28. Ugo Panizza & Federico Sturzenegger & Jeromin Zettelmeyer, 2009. "The Economics and Law of Sovereign Debt and Default," Journal of Economic Literature, American Economic Association, American Economic Association, vol. 47(3), pages 651-98, September.
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Cited by:
  1. Juan Carlos Hatchondo & Leonardo Martinez & Cesar Sosa-Padilla, 2014. "Debt Dilution and Sovereign Default Risk," Department of Economics Working Papers, McMaster University 2014-06, McMaster University.

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