Credit Derivatives and Sovereign Debt Crises
AbstractCredit 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 InfoPaper provided by University Library of Munich, Germany in its series MPRA Paper with number 17314.
Date of creation: 19 Mar 2009
Date of revision:
credit derivatives; sovereign debt crisis; moral hazard;
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
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-09-19 (All new papers)
- NEP-CTA-2009-09-19 (Contract Theory & Applications)
- NEP-FMK-2009-09-19 (Financial Markets)
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