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Voluntary Sovereign Debt Exchanges

  • Juan Carlos Hatchondo
  • Leonardo Martinez
  • Cesar Sosa Padilla

We show that some recent sovereign debt restructurings were characterized by (i) the absence of missed debt payments prior to the restructurings, (ii) reductions in the government’s debt burden, and (iii) increases in the market value of debt claims for holders of the restructured debt. Since both the government and its creditors are likely to benefit from such restructurings, we label these episodes as “voluntary” debt exchanges. We present a model in which voluntary debt exchanges can occur in equilibrium when the debt level takes values above the one that maximizes the market value of debt claims. In contrast to previous studies on debt overhang, in our model opportunities for voluntary exchanges arise because a debt reduction implies a decline of sovereign default risk. This is observed in the absence of any effect of debt reductions on future output levels. Although voluntary exchanges are Pareto improving at the time of the restructuring, we show that eliminating the possibility of conducting voluntary exchanges may improve welfare from an ex-ante perspective. Thus, our results highlight a cost of initiatives that facilitate debt restructurings.

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File URL: http://socserv.mcmaster.ca/econ/rsrch/papers/archive/2013-13.pdf
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Paper provided by McMaster University in its series Department of Economics Working Papers with number 2013-13.

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Length: 37 pages
Date of creation: Aug 2013
Date of revision:
Handle: RePEc:mcm:deptwp:2013-13
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  10. Krugman, Paul, 1988. "Financing vs. forgiving a debt overhang," Journal of Development Economics, Elsevier, vol. 29(3), pages 253-268, November.
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  14. Juan Carlos Hatchondo & Leonardo Martinez, 2013. "Sudden stops, time inconsistency, and the duration of sovereign debt," IMF Working Papers 13/174, International Monetary Fund.
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  21. Cristina Arellano, 2008. "Default Risk and Income Fluctuations in Emerging Economies," American Economic Review, American Economic Association, vol. 98(3), pages 690-712, June.
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  26. Javier Díaz-Cassou & Aitor Erce-Domínguez & Juan J. Vázquez-Zamora, 2008. "Recent episodes of sovereign debt restructurings. A case-study approach," Occasional Papers 0804, Banco de España;Occasional Papers Homepage.
  27. Paul R. Krugman, 1988. "Market-Based Debt-Reduction Schemes," NBER Working Papers 2587, National Bureau of Economic Research, Inc.
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