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Optimal Joint Bond Design

Author

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  • Charles-Henri Weymuller

    (French Treasury)

  • Eduardo Davila

    (New York University)

Abstract

We study the optimal design of a joint borrowing arrangement among countries. In our framework, a safe country, which never defaults, and a risky country, which may default, participate in a joint borrowing scheme, through which they allocate a predetermined fraction of their bond issuance to a joint bond. The joint borrowing scheme is flexible, and can feature pooled issuance, in which countries share the funds raised through the joint bond, and joint liability, in which one country guarantees the obligations of another one. We show that a change in the scale of the joint borrowing scheme affects social welfare through five different channels: the risk sharing channel, the default deadweight loss channel, the free riding channel, the joint liability channel and default spillover channel. We also show that only the first two channels are non-zero up to a first-order when the joint bond issuance is small. We develop a simple test based on pricing data to determine whether a joint borrowing scheme is socially desirable and also conduct a quantitative analysis. We show that our main insights remain valid through a number of extensions.

Suggested Citation

  • Charles-Henri Weymuller & Eduardo Davila, 2016. "Optimal Joint Bond Design," 2016 Meeting Papers 1447, Society for Economic Dynamics.
  • Handle: RePEc:red:sed016:1447
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    File URL: https://economicdynamics.org/meetpapers/2016/paper_1447.pdf
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    1. Lars Ljungqvist & Thomas J. Sargent, 2004. "Recursive Macroeconomic Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026212274x, May.
    2. Kim, Yun Jung & Zhang, Jing, 2012. "Decentralized borrowing and centralized default," Journal of International Economics, Elsevier, vol. 88(1), pages 121-133.
    3. Harold L. Cole & Timothy J. Kehoe, 2000. "Self-Fulfilling Debt Crises," Review of Economic Studies, Oxford University Press, vol. 67(1), pages 91-116.
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    1. repec:eee:streco:v:44:y:2018:i:c:p:100-114 is not listed on IDEAS

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