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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 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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Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 13-08.

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Date of creation: 2013
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Handle: RePEc:fip:fedrwp:13-08
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  1. Juan Carlos Hatchondo & Leonardo Martinez, 2009. "Long-duration bonds and sovereign defaults," Working Paper 08-02, Federal Reserve Bank of Richmond.
  2. 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.
  3. Fernando Broner & Guido Lorenzoni & Sergio L. Schmukler, 2011. "Why Do Emerging Economies Borrow Short Term?," Working Papers 308, Barcelona Graduate School of Economics.
  4. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
  5. Juan Carlos Hatchondo & Leonardo Martinez & Cesar Sosa-Padilla, 2015. "Debt Dilution and Sovereign Default Risk," Caepr Working Papers 2015-012 Classification-, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
  6. Cristina Arellano & Ananth Ramanarayanan, 2008. "Default and the maturity structure in sovereign bonds," Staff Report 410, Federal Reserve Bank of Minneapolis.
  7. Niepelt, Dirk, 2008. "Debt Maturity without Commitment," CEPR Discussion Papers 7093, C.E.P.R. Discussion Papers.
  8. 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.
  9. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-Fulfilling Debt Crises," Levine's Working Paper Archive 114, David K. Levine.
  10. 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.
  11. Satyajit Chatterjee & Burcu Eyigungor, 2011. "Maturity, indebtedness, and default risk," Working Papers 11-33, Federal Reserve Bank of Philadelphia.
  12. Yue, Vivian Z., 2010. "Sovereign default and debt renegotiation," Journal of International Economics, Elsevier, vol. 80(2), pages 176-187, March.
  13. Juan Carlos Hatchondo & Leonardo Martinez & Francisco Roch, 2012. "Fiscal rules and the sovereign default premium," Working Paper 12-01, Federal Reserve Bank of Richmond.
  14. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
  15. 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.
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