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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. 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.
  2. Javier Bianchi & Juan Carlos Hatchondo & Leonardo Martinez, 2013. "International Reserves and Rollover Risk," IMF Working Papers 13/33, International Monetary Fund.
  3. Dirk Niepelt, 2008. "Debt Maturity without Commitment," Working Papers 08.05, Swiss National Bank, Study Center Gerzensee.
  4. 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.
  5. Ananth Ramanarayanan & Cristina Arellano, 2008. "Default and the Maturity Structure in Sovereign Bonds," 2008 Meeting Papers 479, Society for Economic Dynamics.
  6. Leonardo Martinez & Francisco Roch & Juan Hatchondo, 2015. "Fiscal rules and the sovereign default premium," 2015 Meeting Papers 1262, Society for Economic Dynamics.
  7. Harold L. Cole & Timothy J. Kehoe, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Oxford University Press, vol. 67(1), pages 91-116.
  8. 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.
  9. Arellano, Cristina, 2008. "Default risk and income fluctuations in emerging economies," MPRA Paper 7867, University Library of Munich, Germany.
  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. Yue, Vivian Z., 2010. "Sovereign default and debt renegotiation," Journal of International Economics, Elsevier, vol. 80(2), pages 176-187, March.
  12. Satyajit Chatterjee & Burcu Eyigungor, 2011. "Maturity, indebtedness, and default risk," Working Papers 11-33, Federal Reserve Bank of Philadelphia.
  13. Broner, Fernando A. & Lorenzoni, Guido & Schmukler, Sergio L., 2004. "Why do emerging economies borrow short term?," Policy Research Working Paper Series 3389, The World Bank.
  14. 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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