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Credit Derivatives and Sovereign Debt Crises

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  • Goderis, Benedikt
  • Wagner, Wolf

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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Bibliographic Info

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

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References

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  1. Bolton, Patrick & Jeanne, Olivier, 2005. "Structuring and Restructuring Sovereign Debt: The Role of Seniority," CEPR Discussion Papers 4901, C.E.P.R. Discussion Papers.
  2. Michael P. Dooley, 2000. "Can Output Losses Following International Financial Crises be Avoided?," NBER Working Papers 7531, National Bureau of Economic Research, Inc.
  3. Andrew Powell y Leandro Arozamena, 2003. "Liquidity Protection versus Moral Hazard: The Role of the IMF," Business School Working Papers ocho, Universidad Torcuato Di Tella.
  4. 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.
  5. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  6. Gabriella Chiesa, 2008. "Optimal Credit Risk Transfer, Monitored Finance, and Banks," EIEF Working Papers Series 0811, Einaudi Institute for Economics and Finance (EIEF), revised Sep 2008.
  7. Barry Eichengreen, 2003. "Restructuring Sovereign Debt," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 75-98, Fall.
  8. Gregory R. Duffee and Chunsheng Zhou., 1999. "Credit Derivatives in Banking: Useful Tools for Managing Risk?," Research Program in Finance Working Papers RPF-289, University of California at Berkeley.
  9. Jeremy I. Bulow & Kenneth Rogoff, 1988. "Sovereign Debt: Is To Forgive To Forget?," NBER Working Papers 2623, National Bureau of Economic Research, Inc.
  10. Alan Morrison, 2000. "Credit Derivatives, Disintermediation and Investment Decisions," OFRC Working Papers Series 2001fe01, Oxford Financial Research Centre.
  11. José Wynne & Federico Weinschelbaum, 2004. "Renegotiation, Collective Action Clauses and Sovereign Debt Markets," Econometric Society 2004 Latin American Meetings 153, Econometric Society.
  12. Andrei Shleifer, 2003. "Will the Sovereign Debt Market Survive?," NBER Working Papers 9493, National Bureau of Economic Research, Inc.
  13. Sayantan Ghosal & Marcus Miller, 2003. "Co-ordination Failure, Moral Hazard and Sovereign Bankruptcy Procedures," Economic Journal, Royal Economic Society, vol. 113(487), pages 276-304, 04.
  14. 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.
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Cited by:
  1. Patrick Augustin, 2012. "Sovereign Credit Default Swap Premia," Working Papers 12-10, New York University, Leonard N. Stern School of Business, Department of Economics.

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