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Debt dilution and seniority in a model of defaultable sovereign debt

  • Satyajit Chatterjee
  • Burcu Eyigungor

An important source of inefficiency in long-term debt contracts is the debt dilution problem, wherein a borrower ignores the adverse impact of new borrowing on the market value of outstanding debt and, therefore, borrows too much and defaults too frequently. A commonly proposed remedy to the debt dilution problem is seniority of debt, wherein creditors who lent first are given priority in any bankruptcy or restructuring proceedings. The goal of this paper is to incorporate seniority in a quantitatively realistic, infinite horizon model of sovereign debt and default and examine, both theoretically and quantitatively, the extent to which seniority can mitigate the debt dilution problem.

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Paper provided by Federal Reserve Bank of Philadelphia in its series Working Papers with number 12-14.

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Date of creation: 2012
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Handle: RePEc:fip:fedpwp:12-14
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  1. Arellano, Cristina, 2008. "Default risk and income fluctuations in emerging economies," MPRA Paper 7867, University Library of Munich, Germany.
  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. Satyajit Chatterjee & Burcu Eyigungor, 2012. "Maturity, Indebtedness, and Default Risk," American Economic Review, American Economic Association, vol. 102(6), pages 2674-99, October.
  4. Pablo A. Neumeyer & Fabrizio Perri, 2001. "Business Cycles in Emerging Economies:The Role of Interest Rates," Working Papers 01-12, New York University, Leonard N. Stern School of Business, Department of Economics.
  5. Diego Saravia, 2009. "On The Role and Effects of IMF Seniority," Working Papers Central Bank of Chile 538, Central Bank of Chile.
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  7. Cristina Arellano & Ananth Ramanarayanan, 2008. "Default and the maturity structure in sovereign bonds," Staff Report 410, Federal Reserve Bank of Minneapolis.
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  9. Aguiar, Mark & Gopinath, Gita, 2006. "Defaultable debt, interest rates and the current account," Journal of International Economics, Elsevier, vol. 69(1), pages 64-83, June.
  10. Hatchondo, Juan Carlos & Martinez, Leonardo, 2009. "Long-duration bonds and sovereign defaults," Journal of International Economics, Elsevier, vol. 79(1), pages 117-125, September.
  11. Eduardo Borensztein & Olivier Jeanne & Paolo Mauro & Jeromin Zettelmeyer & Marcos Chamon, 2005. "Sovereign Debt Structure for Crisis Prevention," IMF Occasional Papers 237, International Monetary Fund.
  12. Cole, Harold L. & Kehoe, Timothy J., 1996. "A self-fulfilling model of Mexico's 1994-1995 debt crisis," Journal of International Economics, Elsevier, vol. 41(3-4), pages 309-330, November.
  13. Jeffrey Sachs & Daniel Cohen, 1982. "LDC Borrowing with Default Risk," NBER Working Papers 0925, National Bureau of Economic Research, Inc.
  14. Michael P. Dooley, 2000. "Can Output Losses Following International Financial Crises be Avoided?," NBER Working Papers 7531, National Bureau of Economic Research, Inc.
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