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Credit Derivatives and Sovereign Debt Crises

  • Goderis, Benedikt
  • Wagner, Wolf

Credit derivatives allow for buying protection on corporate debt, but also on sovereign debt. In this paper we examine the implications for sovereign debt crises. We show that the availability of credit protection lowers ex-ante debtor moral hazard by allowing a bondholder to improve his bargaining position in negotiations with the sovereign, thus forcing the sovereign to internalize more of the costs of a crisis. When bondholders use credit protection strategically, we additionally find that credit derivatives do not hinder an efficient resolution of crises. Crisis resolution may even be improved by facilitating conditionality. When protection is not chosen strategically, however, credit protection may also be detrimental to crisis resolution by making restructuring more difficult. In either case we identify a role for government policy as bondholders' choice of protection is not necessarily socially efficient.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 17314.

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Date of creation: 19 Mar 2009
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Handle: RePEc:pra:mprapa:17314
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  1. Duffee, Gregory R. & Zhou, Chunsheng, 2001. "Credit derivatives in banking: Useful tools for managing risk?," Journal of Monetary Economics, Elsevier, vol. 48(1), pages 25-54, August.
  2. Andrei Shleifer, 2003. "Will the Sovereign Debt Market Survive?," NBER Working Papers 9493, National Bureau of Economic Research, Inc.
  3. Powell, Andrew & Arozamena, Leandro, 2003. "Liquidity protection versus moral hazard: the role of the IMF," Journal of International Money and Finance, Elsevier, vol. 22(7), pages 1041-1063, December.
  4. Bulow, J. & Rogoff, K., 1988. "Sovereign Debt: Is To Forgive To Forget?," Papers 411, Stockholm - International Economic Studies.
  5. Weinschelbaum, Federico & Wynne, Jose, 2005. "Renegotiation, collective action clauses and sovereign debt markets," Journal of International Economics, Elsevier, vol. 67(1), pages 47-72, September.
  6. Alan Morrison, 2000. "Credit Derivatives, Disintermediation and Investment Decisions," OFRC Working Papers Series 2001fe01, Oxford Financial Research Centre.
  7. Ghosal, Sayantan & Miller, Marcus, 2003. "Coordination Failure, Moral Hazard and Sovereign Bankruptcy Procedures," CEPR Discussion Papers 3729, C.E.P.R. Discussion Papers.
  8. Chiesa, Gabriella, 2008. "Optimal credit risk transfer, monitored finance, and banks," Journal of Financial Intermediation, Elsevier, vol. 17(4), pages 464-477, October.
  9. Gai, Prasanna & Hayes, Simon & Shin, Hyun Song, 2004. "Crisis costs and debtor discipline: the efficacy of public policy in sovereign debt crises," Journal of International Economics, Elsevier, vol. 62(2), pages 245-262, March.
  10. Frank Packer & Chamaree Suthiphongchai, 2003. "Sovereign credit default swaps," BIS Quarterly Review, Bank for International Settlements, December.
  11. Barry Eichengreen, 2003. "Restructuring Sovereign Debt," Journal of Economic Perspectives, American Economic Association, vol. 17(4), pages 75-98, Fall.
  12. Patrick Bolton & Olivier Jeanne, 2005. "Structuring and Restructuring Sovereign Debt: The Role of Seniority," NBER Working Papers 11071, National Bureau of Economic Research, Inc.
  13. 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.
  14. Michael P. Dooley, 2000. "Can Output Losses Following International Financial Crises be Avoided?," NBER Working Papers 7531, National Bureau of Economic Research, Inc.
  15. Andrew G Haldane & Adrian Penalver & Victoria Saporta & Hyun Song Shin, 2003. "Analytics of sovereign debt restructuring," Bank of England working papers 203, Bank of England.
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