In evaluating the benefits of a voluntary debt reduction scheme, look for efficiency gains that allow both debtor and creditor to gain. In particular certain debt reduction operations can: (i) increase the incentives for growth in highly indebted countries; (ii) allocate risk more efficiently between debtor and creditors; and (iii) signal the credibility of a country's willingness to adjust its economy. Market-based debt conversion is more likely to improve the debtor nations welfare when: (i) the opportunity cost of foreign exchange is low; (ii) there is great probability of default with a deadweight loss to the creditor; (iii) private rather than public debt is swapped for equity investments; (iv) the country has no other way of signalling its commitment; and (v) the country has an extreme case of debt overhang.
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Jonathan Eaton & Raquel Fernandez, 1995.
"Sovereign Debt,"
NBER Working Papers
5131, National Bureau of Economic Research, Inc.
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Eaton, J. & Fernandez, R., 1995.
"Sovereign Debt,"
Papers
37, Boston University - Department of Economics.
Eaton, Jonathan & Fernandez, Raquel, 1995.
"Sovereign debt,"
Handbook of International Economics,
in: G. M. Grossman & K. Rogoff (ed.), Handbook of International Economics, edition 1, volume 3, chapter 3, pages 2031-2077
Elsevier.
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