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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
Date of revision:
Handle: RePEc:red:sed013:654
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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  1. Diego Saravia, 2009. "On The Role and Effects of IMF Seniority," Working Papers Central Bank of Chile 538, Central Bank of Chile.
  2. Satyajit Chatterjee & Burcu Eyigungor, 2009. "Maturity, Indebtedness, and Default Risk," Koç University-TUSIAD Economic Research Forum Working Papers 0901, Koc University-TUSIAD Economic Research Forum.
  3. Juan Carlos Hatchondo & Leonardo Martinez & Cesar Sosa-Padilla, 2015. "Debt Dilution and Sovereign Default Risk," Caepr Working Papers 2015-012 Classification-, Center for Applied Economics and Policy Research, Economics Department, Indiana University Bloomington.
  4. Eduardo Borensztein & Olivier D Jeanne & Paolo Mauro & Jeronimo Zettelmeyer & Marcos d Chamon, 2005. "Sovereign Debt Structure for Crisis Prevention," IMF Occasional Papers 237, International Monetary Fund.
  5. Hatchondo, Juan Carlos & Martinez, Leonardo, 2009. "Long-duration bonds and sovereign defaults," Journal of International Economics, Elsevier, vol. 79(1), pages 117-125, September.
  6. Michael P. Dooley, 2000. "Can Output Losses Following International Financial Crises be Avoided?," NBER Working Papers 7531, National Bureau of Economic Research, Inc.
  7. 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.
  8. Jonathan Eaton & Mark Gersovitz, 1981. "Debt with Potential Repudiation: Theoretical and Empirical Analysis," Review of Economic Studies, Oxford University Press, vol. 48(2), pages 289-309.
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