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Sovereign Default Resolution Through Maturity Extension

Listed author(s):
  • Gabriel Mihalache

Sovereigns resolve their default status by offering bond swaps to their lenders, usually following negotiations. We model this interaction in a quantitative model of borrowing and default, and focus on its consequences for debt levels, default risk, and haircuts. The empirical literature finds that the bulk of debt relief is implemented by lengthening the maturity of debt, rather than changing face value. Countries exit renegotiations with less debt but with a greater share of long-term debt in total, compared to the maturity structure at the time of default. A standard maturity choice model, augmented with a renegotiation phase, is unable to replicate this critical feature of the data. We explain this negative result by showing an equivalence between the choice of maturity during the swap and and at issuance, in key states of the world. Introducing a demand shock solves the puzzle. We interpret this reduced-form shock in the context of the literature on political turnover risk. It captures in a parsimonious way the notion that emerging markets may elect policy-makers more prone to short-termism.

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File URL: http://www.stonybrook.edu/commcms/economics/research/papers/2017/Mihalache_1708.pdf
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Paper provided by Stony Brook University, Department of Economics in its series Department of Economics Working Papers with number 17-08.

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Date of creation: 2017
Handle: RePEc:nys:sunysb:17-08
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Stony Brook, NY 11794-4384

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Web page: http://www.stonybrook.edu/commcms/economics/
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