Three-player sovereign debt negotiations

This paper models sovereign debt negotiations between a debtor country (player 1) and its international official-sector (player 2) and private-sector (player 3) creditors. The presence of a third player allows for the formation of coalitions between two players. If there are key players that are part of all credible coalitions, such as creditors jointly imposing a partial refinancing agreement on a small debtor country, restructuring negotiations can be impaired and may result in partial default resolutions. These suboptimal bargaining outcomes are triggered when creditors stop extending a full refinancing agreement upon experiencing regret when learning that a partial agreement would have offered a higher return in the past. The introduction of regret allows the model to capture the extend-and-pretend approach that creditors frequently adopt in sovereign debt negotiations. Bounded rationality in the form of concerns for past outcomes, however, is insufficient to create bargaining inefficiencies. Suboptimal refinancing agreements are instead due to the existence of bargaining strength asymmetries, which implies that limiting the dominating presence of key players may help to restore efficiency to sovereign debt negotiations.