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Bargained haircuts and debt policy implications

Author

Listed:
  • Aloisio Araujo

    (IMPA and EPGE/FGV)

  • Marcia Leon

    (Research Department, Banco Central do Brasil)

  • Rafael Santos

    (Research Department, Banco Central do Brasil
    EPGE/FGV)

Abstract

We extend the Cole and Kehoe model (J Int Econ 41:309–330, 1996) by adding a Rubinstein bargaining game between creditors and debtor country to determine the share of debt repayment in a sovereign debt crisis. Ex-post, the possibility of partial repayment avoids the costly case of total default, as seen recently in Greece. Ex-ante, the effects are to increase the sovereign debt cap and delay the fiscal adjustment. In other words, expectations of a haircut in times of crisis relax leverage restrictions implied by financial markets and make government more lenient, suggesting caution with haircut adoption, especially when risk-free interest rates are low.

Suggested Citation

  • Aloisio Araujo & Marcia Leon & Rafael Santos, 2017. "Bargained haircuts and debt policy implications," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 64(4), pages 635-656, December.
    • Handle: RePEc:spr:joecth:v:64:y:2017:i:4:d:10.1007_s00199-016-0981-4
    DOI: 10.1007/s00199-016-0981-4
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    Cited by:

    1. Zhongwei Feng & Chunqiao Tan & Jinchun Zhang & Qiang Zeng, 2021. "Bargaining Game with Altruistic and Spiteful Preferences," Group Decision and Negotiation, Springer, vol. 30(2), pages 277-300, April.
    2. Cristina Arellano & Timothy J. Kehoe & Herakles Polemarchakis, 2017. "Introduction to the Special Issue on Models of Debt and Debt Crises," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 64(4), pages 605-610, December.
    3. Redouane Elkamhi & Latchezar Popov & Raunaq S. Pungaliya, 2023. "Financial maintenance covenants in bank loans," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 76(4), pages 1197-1255, November.

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    More about this item

    Keywords

    Partial default; Speculative attacks; Debt crisis; Leverage;
    All these keywords.

    JEL classification:

    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G01 - Financial Economics - - General - - - Financial Crises
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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