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Debt Dilution and Seniority in a Model of Defaultable Sovereign Debt

  • Satyajit Chatterjee

    (Federal Reserve Bank of Philadelphia)

  • Burcu Eyigungor

    (Phildalephia Federal Reserve Bank)

An important source of inefficiency in long-term debt contracts is the debt dilution problem, wherein a borrower ignores the adverse impact of new borrowing on the market value of outstanding debt and, therefore, borrows too much and defaults too frequently. A commonly proposed remedy to the debt dilution problem is seniority of debt, wherein creditors who lent first are given priority in any bankruptcy or restructuring proceedings. The goal of this paper is to incorporate seniority in a quantitatively realistic, infinite horizon model of sovereign debt and default and examine, both theoretically and quantitatively, the extent to which seniority can mitigate the debt dilution problem.

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Paper provided by Society for Economic Dynamics in its series 2013 Meeting Papers with number 654.

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Date of creation: 2013
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Handle: RePEc:red:sed013:654
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  1. Satyajit Chatterjee & Burcu Eyigungor, 2012. "Maturity, Indebtedness, and Default Risk," American Economic Review, American Economic Association, vol. 102(6), pages 2674-99, October.
  2. Diego Saravia, 2007. "On the Role and Effects of IMF Seniority," Documentos de Trabajo 317, Instituto de Economia. Pontificia Universidad Católica de Chile..
  3. Leonardo Martinez & Juan Carlos Hatchondo & Cesar Sosa Padilla, 2011. "Debt Dilution and Sovereign Default Risk," IMF Working Papers 11/70, International Monetary Fund.
  4. Michael P. Dooley, 2000. "Can Output Losses Following International Financial Crises be Avoided?," NBER Working Papers 7531, National Bureau of Economic Research, Inc.
  5. Cristina Arellano & Ananth Ramanarayanan, 2008. "Default and the maturity structure in sovereign bonds," Globalization and Monetary Policy Institute Working Paper 19, Federal Reserve Bank of Dallas.
  6. Neumeyer, Pablo A. & Perri, Fabrizio, 2005. "Business cycles in emerging economies: the role of interest rates," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 345-380, March.
  7. Aguiar, Mark & Gopinath, Gita, 2006. "Defaultable debt, interest rates and the current account," Journal of International Economics, Elsevier, vol. 69(1), pages 64-83, June.
  8. Eduardo Borensztein & Olivier Jeanne & Paolo Mauro & Jeromin Zettelmeyer & Marcos Chamon, 2005. "Sovereign Debt Structure for Crisis Prevention," IMF Occasional Papers 237, International Monetary Fund.
  9. Jeffrey Sachs & Daniel Cohen, 1982. "LDC Borrowing with Default Risk," NBER Working Papers 0925, National Bureau of Economic Research, Inc.
  10. 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.
  11. Cole, Harold L. & Kehoe, Timothy J., 1996. "A self-fulfilling model of Mexico's 1994-1995 debt crisis," Journal of International Economics, Elsevier, vol. 41(3-4), pages 309-330, November.
  12. Arellano, Cristina, 2008. "Default risk and income fluctuations in emerging economies," MPRA Paper 7867, University Library of Munich, Germany.
  13. Hatchondo, Juan Carlos & Martinez, Leonardo, 2009. "Long-duration bonds and sovereign defaults," Journal of International Economics, Elsevier, vol. 79(1), pages 117-125, September.
  14. David Benjamin, 2008. "Recovery Before Redemption," 2008 Meeting Papers 531, Society for Economic Dynamics.
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