IDEAS home Printed from https://ideas.repec.org/p/red/sed006/652.html
   My bibliography  Save this paper

Debt Dilution and Maturity Structure of Sovereign Bonds

Author

Listed:
  • Ran Bi

Abstract

We develop a dynamic model of sovereign default and renegotiation to study how expectations of default and debt restructuring in the near future affect the ex ante maturity structure of sovereign debts. This paper argues that the average maturity is shorter when a country is approaching financial distress due to two risks: default risk and "debt dilution" risk. Long-term yield is generally higher than short-term yield to reflect the higher default risk incorporated in long-term debts. When default risk is high and long-term debt is too expensive to afford, the country near default has to rely on short-term debt. The second risk, "debt dilution" risk, is the focus of this paper. It arises because there is no explicit seniority structure among different sovereign debts, and all debt holders are legally equal and expect to get the same haircut rate in the post-default debt restructuring. Therefore, new debt issuances around crisis reduce the amount that can be recovered by existing earlier debt-holders in debt restructuring, and thus ``dilute'' existing debts. As a result, investors tend to hold short-term debt which is more likely to mature before it is "diluted" to avoid the "dilution" risk. Model features non-contingent bonds of two maturities, endogenous default and endogenous hair cut rate in a debt renegotiation after default. We show that ``debt dilution'' effect is always present and is more severe when default risk is high. When default is a likely event in the near future, both default risk and ``dilution'' risk drive the ex ante maturity of sovereign debts to be shorter. In a quantitative analysis, we try to calibrate the model to match various features of the recent crisis episode of Argentina. In particular, we try to account for the shifts in maturity structure before crisis and the volatility of long-term and short-term spreads observed in the prior default episode of Argentina

Suggested Citation

  • Ran Bi, 2006. "Debt Dilution and Maturity Structure of Sovereign Bonds," 2006 Meeting Papers 652, Society for Economic Dynamics.
  • Handle: RePEc:red:sed006:652
    as

    Download full text from publisher

    File URL: http://repec.org/sed2006/up.27389.1140027188.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Harold L. Cole & Timothy J. Kehoe, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Oxford University Press, vol. 67(1), pages 91-116.
    2. Grossman, Herschel I & Van Huyck, John B, 1988. "Sovereign Debt as a Contingent Claim: Excusable Default, Repudiation, and Reputation," American Economic Review, American Economic Association, vol. 78(5), pages 1088-1097, December.
    3. Alan Schwartz, 1997. "Priority Contracts and Priority in Bankruptcy," Yale School of Management Working Papers ysm72, Yale School of Management.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Diego Saravia, 2010. "Vulnerability, Crisis and Debt Maturity: do IMF Interventions Shorten the Length of Borrowing?," Working Papers Central Bank of Chile 600, Central Bank of Chile.
    2. Kim, Yun Jung & Zhang, Jing, 2012. "Decentralized borrowing and centralized default," Journal of International Economics, Elsevier, vol. 88(1), pages 121-133.

    More about this item

    Keywords

    Maturity Structure; Debt Dilution; Sovereign Default; Debt Renegotiation;

    JEL classification:

    • F32 - International Economics - - International Finance - - - Current Account Adjustment; Short-term Capital Movements
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:red:sed006:652. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christian Zimmermann). General contact details of provider: http://edirc.repec.org/data/sedddea.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.