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Bank loans versus bond finance: implications for sovereign debtors

  • Misa Tanaka

This paper develops a model to analyse the optimal choice between bank loans and bond finance for a sovereign debtor. We show that if banks have better information about their borrowers compared to bondholders, only the least risky sovereigns issue bonds. But if borrowers can be 'publicly monitored' by an outside agency that disseminates the information about their creditworthiness, their choice between bank loans and bond finance is determined endogenously by the trade-off between two deadweight costs: the crisis cost of a sovereign default and the cost of debtor moral hazard. In equilibrium, sovereigns use bank loans for financing short-term projects and bond issuance for projects with uncertain timing of cash flows if crisis costs are large. We also demonstrate that state-contingent debt and IMF intervention can improve welfare.

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File URL: http://www.bankofengland.co.uk/research/Documents/workingpapers/2005/WP267.pdf
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Paper provided by Bank of England in its series Bank of England working papers with number 267.

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Date of creation: Jul 2005
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Handle: RePEc:boe:boeewp:267
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  1. Rajan, Raghuram G, 1992. " Insiders and Outsiders: The Choice between Informed and Arm's-Length Debt," Journal of Finance, American Finance Association, vol. 47(4), pages 1367-400, September.
  2. Eduardo Borensztein & Paolo Mauro, 2002. "Reviving the Case for GDP-Indexed Bonds," IMF Policy Discussion Papers 02/10, International Monetary Fund.
  3. Bolton, Patrick & Scharfstein, David S, 1996. "Optimal Debt Structure and the Number of Creditors," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 1-25, February.
  4. Stephen Morris & Hyun Song Shin, 1999. "Coordination Risk and the Price of Debt," Cowles Foundation Discussion Papers 1241, Cowles Foundation for Research in Economics, Yale University.
  5. Haldane, Andrew G. & Penalver, Adrian & Saporta, Victoria & Shin, Hyun Song, 2005. "Analytics of sovereign debt restructuring," Journal of International Economics, Elsevier, vol. 65(2), pages 315-333, March.
  6. Michael P. Dooley, 2000. "Can Output Losses Following International Financial Crises be Avoided?," NBER Working Papers 7531, National Bureau of Economic Research, Inc.
  7. Mark M. Spiegel, 2000. "Solvency runs, sunspot runs, and international bailouts," Working Paper Series 2001-05, Federal Reserve Bank of San Francisco.
  8. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
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