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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. Cristina Arellano & Ananth Ramanarayanan, 2012. "Default and the Maturity Structure in Sovereign Bonds," Journal of Political Economy, University of Chicago Press, vol. 120(2), pages 187 - 232.
  2. Leonardo Martinez & Juan Carlos Hatchondo & Cesar Sosa Padilla, 2011. "Debt Dilution and Sovereign Default Risk," IMF Working Papers 11/70, International Monetary Fund.
  3. Kristin J. Forbes & Francis E. Warnock, 2011. "Capital Flow Waves: Surges, Stops, Flight, and Retrenchment," NBER Working Papers 17351, National Bureau of Economic Research, Inc.
  4. Eaton, Jonathan & Gersovitz, Mark, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Wiley Blackwell, vol. 48(2), pages 289-309, April.
  5. Fernando Broner & Guido Lorenzoni & Sergio Schmuckler, 2006. "Why Do Emerging Economies Borrow Short Term?," 2006 Meeting Papers 841, Society for Economic Dynamics.
  6. Dirk Niepelt, 2008. "Debt Maturity without Commitment," CESifo Working Paper Series 2500, CESifo Group Munich.
  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. Vivian Z. Yue, 2005. "Sovereign Default and Debt Renegotiation," 2005 Meeting Papers 138, Society for Economic Dynamics.
  9. Satyajit Chatterjee & Burcu Eyigungor, 2012. "Maturity, Indebtedness, and Default Risk," American Economic Review, American Economic Association, vol. 102(6), pages 2674-99, October.
  10. Javier Bianchi & Juan Carlos Hatchondo & Leonardo Martinez, 2012. "International Reserves and Rollover Risk," NBER Working Papers 18628, National Bureau of Economic Research, Inc.
  11. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
  12. Juan Carlos Hatchondo & Francisco Roch & Leonardo Martinez, 2012. "Fiscal Rules and the Sovereign Default Premium," IMF Working Papers 12/30, International Monetary Fund.
  13. Juan Carlos Hatchondo & Leonardo Martinez, 2009. "Long-duration bonds and sovereign defaults," Working Paper 08-02, Federal Reserve Bank of Richmond.
  14. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-fulfilling debt crises," Staff Report 211, Federal Reserve Bank of Minneapolis.
  15. Leonardo Martinez & Horacio Sapriza & Juan Carlos Hatchondo, 2010. "Quantitative Properties of Sovereign Default Models; Solution Methods Matter," IMF Working Papers 10/100, International Monetary Fund.
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