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Is the discount on the secondary market a case for LDC debt relief?

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  • Cohen, Daniel

Abstract

In 1988, the prices on the secondary market of LDC debt averaged 50 cents per dollar of face value. From the observation of such discount, this paper goes one step further and argues thatthe debt should be written down in order to account for the discrepancy between the face and market value of the debt. The paper is structured as follows. Section 1 spells out the model, section 2 calculates the socially efficient and the post-default growth rates of the economy. Section 3 shows that the lenders, if they were to monitor the investment and the consumption strategy of the borrower, would choose a lower investment strategy than the socially efficient one. Section 4 shows how an optimum rescheduling can achieve the equilibrium described in section 3. Section 5 shows the dynamic inconsistency of the optimal strategy spelled out in section 4, and shows the link with the"debt overhang"literature. Section 6 investigates the empirical relevance of the"debt overhang".

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Bibliographic Info

Paper provided by The World Bank in its series Policy Research Working Paper Series with number 132.

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Date of creation: 30 Nov 1988
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Handle: RePEc:wbk:wbrwps:132

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Keywords: Economic Theory&Research; Banks&Banking Reform; Environmental Economics&Policies; Strategic Debt Management; Financial Intermediation;

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References

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  1. Jeremy A.Rogoff Bulow & Kenneth, 1986. "A Constant Recontracting Model of Sovereign Debt," University of Chicago - George G. Stigler Center for Study of Economy and State, Chicago - Center for Study of Economy and State 43, Chicago - Center for Study of Economy and State.
  2. Jeffrey Sachs & Harry Huizinga, 1987. "U.S. Commercial Banks and the Developing Country Debt Crisis," NBER Working Papers 2455, National Bureau of Economic Research, Inc.
  3. Cohen, Daniel & Sachs, Jeffrey, 1986. "Growth and external debt under risk of debt repudiation," European Economic Review, Elsevier, vol. 30(3), pages 529-560, June.
  4. Cohen, Daniel & Michel, Philippe, 1988. "How Should Control Theory Be Used to Calculate a Time-Consistent Government Policy?," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 55(2), pages 263-74, April.
  5. Rudiger Dornbusch & Thomas S. Johnson & Anne O. Krueger, 1988. "Our LDC Debts," NBER Chapters, in: The United States in the World Economy, pages 161-214 National Bureau of Economic Research, Inc.
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Cited by:
  1. Ozler, Sule & Huizinga, Harry, 1991. "How factors in creditor countries affect secondary market prices for developing country debt," Policy Research Working Paper Series 622, The World Bank.
  2. Aasim Mairaj Husain, 1988. "Forgiveness, Buybacks, and Exit Bonds: An Analysis of Alternate Debt Relief Strategiest," The Pakistan Development Review, Pakistan Institute of Development Economics, vol. 27(4), pages 819-828.
  3. Corsepius, Uwe, 1989. "Peru at the brink of economic collapse: Current problems and policy options," Kiel Discussion Papers 153, Kiel Institute for the World Economy (IfW).
  4. Nunnenkamp, Peter, 1989. "Capital drain, debt relief, and creditworthiness of developing countries," Kiel Working Papers 379, Kiel Institute for the World Economy.
  5. Claessens, Stijn & Diwan, Ishac, 1990. "Methodological issues in evaluating debt - reducing deals," Policy Research Working Paper Series 408, The World Bank.
  6. Diwan, Ishac & Kletzer, Ken, 1990. "Voluntary choices in concerted deals : mechanics and attributes of the menu approach," Policy Research Working Paper Series 527, The World Bank.

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