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Credit Derivatives and Sovereign Debt Crises

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Author Info
Goderis, Benedikt
Wagner, Wolf

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Abstract

Credit derivatives allow for buying protection on corporate debt, but also on sovereign debt. In this paper we examine the implications for sovereign debt crises. We show that the availability of credit protection lowers ex-ante debtor moral hazard by allowing a bondholder to improve his bargaining position in negotiations with the sovereign, thus forcing the sovereign to internalize more of the costs of a crisis. When bondholders use credit protection strategically, we additionally find that credit derivatives do not hinder an efficient resolution of crises. Crisis resolution may even be improved by facilitating conditionality. When protection is not chosen strategically, however, credit protection may also be detrimental to crisis resolution by making restructuring more difficult. In either case we identify a role for government policy as bondholders' choice of protection is not necessarily socially efficient.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 17314.

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Date of creation: 19 Mar 2009
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Handle: RePEc:pra:mprapa:17314

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Related research
Keywords: credit derivatives; sovereign debt crisis; moral hazard;

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Find related papers by JEL classification:
G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies
F34 - International Economics - - International Finance - - - International Lending and Debt Problems
F33 - International Economics - - International Finance - - - International Monetary Arrangements and Institutions

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References listed on IDEAS
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  1. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Blackwell Publishing, vol. 48(2), pages 289-309, April. [Downloadable!] (restricted)
  2. Barry Eichengreen, 2003. "Restructuring Sovereign Debt," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 75-98, Fall. [Downloadable!] (restricted)
  3. Bolton, Patrick & Jeanne, Olivier, 2005. "Structuring and Restructuring Sovereign Debt: The Role of Seniority," CEPR Discussion Papers 4901, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
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  4. Bulow, Jeremy & Rogoff, Kenneth, 1989. "Sovereign Debt: Is to Forgive to Forget?," American Economic Review, American Economic Association, vol. 79(1), pages 43-50, March. [Downloadable!] (restricted)
    Other versions:
  5. Powell, Andrew & Arozamena, Leandro, 2003. "Liquidity protection versus moral hazard: the role of the IMF," Journal of International Money and Finance, Elsevier, vol. 22(7), pages 1041-1063, December. [Downloadable!] (restricted)
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  6. Gai, Prasanna & Hayes, Simon & Shin, Hyun Song, 2004. "Crisis costs and debtor discipline: the efficacy of public policy in sovereign debt crises," Journal of International Economics, Elsevier, vol. 62(2), pages 245-262, March. [Downloadable!] (restricted)
  7. Andrei Shleifer, 2003. "Will the Sovereign Debt Market Survive?," NBER Working Papers 9493, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Michael P. Dooley, 2000. "Can Output Losses Following International Financial Crises be Avoided?," NBER Working Papers 7531, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  9. Jose Wynne & Federico Weinschelbaum, 2004. "Renegotiation, Collective Action Clauses and Sovereign Debt Markets," 2004 Meeting Papers 7, Society for Economic Dynamics. [Downloadable!]
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  10. Duffee, Gregory R. & Zhou, Chunsheng, 2001. "Credit derivatives in banking: Useful tools for managing risk?," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 25-54, August. [Downloadable!] (restricted)
  11. Haldane, Andrew G. & Penalver, Adrian & Saporta, Victoria & Shin, Hyun Song, 2005. "Analytics of sovereign debt restructuring," Journal of International Economics, Elsevier, vol. 65(2), pages 315-333, March. [Downloadable!] (restricted)
  12. Alan Morrison, 2000. "Credit Derivatives, Disintermediation and Investment Decisions," OFRC Working Papers Series 2001fe01, Oxford Financial Research Centre. [Downloadable!]
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