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Sovereign Default Resolution Through Maturity Extension

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  • Gabriel Mihalache

Abstract

Sovereign default episodes are eventually resolved by restructuring the debt, through negotiations with the lenders, and implemented by bond swaps and resumption of debt service payments. This process partially compensate lenders for their losses and provide debt relief for the sovereign. The empirical literature studying these events emphasizes that the bulk of debt relief is implemented by lengthening the maturity of debt, rather than changing face value. Countries exit renegotiation with less debt but with a greater share of long-term debt in total, compared to the maturity structure at the time of default. We augment a standard maturity choice model with a post-default renegotiation phase and study whether it can replicate this observed maturity extension in the data. The model is successful in generating this and other key features of renegotiations and maturity choice, but critically only when we assume that countries continue to be temporarily excluded from financial markets after renegotiation, as in the data. A version of the model where the sovereign can immediately resume borrowing following renegotiation features instead a counterfactual reduction in maturity. We interpret these findings in terms of the tension between the sovereign’s preference for consumption smoothing and the inefficiency of debt dilution inherent in long-term debt.

Suggested Citation

  • Gabriel Mihalache, 2017. "Sovereign Default Resolution Through Maturity Extension," Department of Economics Working Papers 17-08, Stony Brook University, Department of Economics.
  • Handle: RePEc:nys:sunysb:17-08
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    File URL: http://www.stonybrook.edu/commcms/economics/research/papers/2017/Mihalache_1708.pdf
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    File URL: http://www.stonybrook.edu/commcms/economics/research/papers/2017/Mihalache_v2_1708.pdf
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    References listed on IDEAS

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    Cited by:

    1. Xavier Mateos-Planas & Jose-Victor Rios-Rull & Cristina Arellano, 2013. "Partial Default," 2013 Meeting Papers 765, Society for Economic Dynamics.
    2. Maximiliano Dvorkin & Emircan Yurdagul & Horacio Sapriza & Juan Sanchez, 2018. "Sovereign Debt Restructuring: A Dynamic Discrete Choice Approach," 2018 Meeting Papers 1273, Society for Economic Dynamics.
    3. Juan M. Sanchez & Maximiliano Dvorkin & Emircan Yurdagul & Horacio Sapriza, 2018. "Sovereign Debt Restructurings," Working Papers 2018-13, Federal Reserve Bank of St. Louis, revised 27 Feb 2019.
    4. Corsetti, Giancarlo & Erce, Aitor & Uy, Timothy, 2018. "Debt Sustainability and the Terms of Official Support," CEPR Discussion Papers 13292, C.E.P.R. Discussion Papers.

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