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Sudden Stops, Time Inconsistency, and the Duration of Sovereign Debt

  • Juan Carlos Hatchondo
  • Leonardo Martinez

We study the sovereign debt duration chosen by the government in the context of a standard model of sovereign default. The government balances off increasing the duration of its debt to mitigate rollover risk and lowering duration to mitigate the debt dilution problem. We present two main results. First, when the government decides the debt duration on a sequential basis, sudden stop risk increases the average duration by 1 year. Second, we illustrate the time inconsistency problem in the choice of sovereign debt duration: governments would like to commit to a duration that is 1.7 years shorter than the one they choose when decisions are made sequentially.

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File URL: http://hdl.handle.net/10.1080/10168737.2013.796112
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Article provided by Taylor & Francis Journals in its journal International Economic Journal.

Volume (Year): 27 (2013)
Issue (Month): 2 (June)
Pages: 217-228

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Handle: RePEc:taf:intecj:v:27:y:2013:i:2:p:217-228
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  1. Yue, Vivian Z., 2010. "Sovereign default and debt renegotiation," Journal of International Economics, Elsevier, vol. 80(2), pages 176-187, March.
  2. Ananth Ramanarayanan & Cristina Arellano, 2008. "Default and the Maturity Structure in Sovereign Bonds," 2008 Meeting Papers 479, Society for Economic Dynamics.
  3. Fernando Broner & Guido Lorenzoni & Sergio L. Schmukler, 2003. "Why do emerging economies borrow short term?," Economics Working Papers 838, Department of Economics and Business, Universitat Pompeu Fabra, revised Dec 2011.
  4. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
  5. Juan Carlos Hatchondo & Leonardo Martinez, 2012. "Debt dilution and sovereign default risk," Working Paper 10-08, Federal Reserve Bank of Richmond.
  6. Hatchondo, Juan Carlos & Martinez, Leonardo, 2009. "Long-duration bonds and sovereign defaults," Journal of International Economics, Elsevier, vol. 79(1), pages 117-125, September.
  7. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
  8. Dirk Niepelt, 2008. "Debt Maturity without Commitment," Working Papers 08.05, Swiss National Bank, Study Center Gerzensee.
  9. Juan Carlos Hatchondo & Francisco Roch & Leonardo Martinez, 2012. "Fiscal Rules and the Sovereign Default Premium," IMF Working Papers 12/30, International Monetary Fund.
  10. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-fulfilling debt crises," Staff Report 211, Federal Reserve Bank of Minneapolis.
  11. Bianchi, Javier & Hatchondo, Juan Carlos & Martinez, Leonardo, 2013. "International reserves and rollover risk," Working Paper 13-01, Federal Reserve Bank of Richmond, revised 01 Jun 2013.
  12. Kristin J. Forbes & Francis E. Warnock, 2011. "Capital Flow Waves: Surges, Stops, Flight, and Retrenchment," NBER Chapters, in: Global Financial Crisis National Bureau of Economic Research, Inc.
  13. Satyajit Chatterjee & Burcu Eyigungor, 2011. "Maturity, indebtedness, and default risk," Working Papers 11-33, Federal Reserve Bank of Philadelphia.
  14. Juan Carlos Hatchondo & Leonardo Martinez & Horacio Sapriza, 2010. "Quantitative properties of sovereign default models: solution methods matter," Working Paper 10-04, Federal Reserve Bank of Richmond.
  15. Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 289-309.
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