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We develop a sovereign debt model with official and private creditors where default risk depends on both the level and the composition of liabilities. Higher exposure to official lenders improves incentives to repay but carries extra costs, such as reduced ex-post flexibility. The model implies that official lending to sovereigns takes place in times of debt distress; carries a favorable rate; and can displace private funding even under pari passu provisions. Moreover, in the presence of long-term debt overhang, the availability of official funds increases the probability of default on existing debt, although default does not trigger exclusion from private credit markets. These findings help shed light on joint default and debt composition choices of the type observed during the recent sovereign debt crisis in Europe.

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Paper provided by Swiss National Bank, Study Center Gerzensee in its series Working Papers with number 13.05.

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Length: 28 pages
Date of creation: May 2013
Date of revision:
Handle: RePEc:szg:worpap:1305
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  1. Niepelt, Dirk, 2014. "Debt maturity without commitment," Journal of Monetary Economics, Elsevier, vol. 68(S), pages S37-S54.
  2. Patrick Bolton & Olivier Jeanne, 2011. "Sovereign Default Risk and Bank Fragility in Financially Integrated Economies," IMF Economic Review, Palgrave Macmillan;International Monetary Fund, vol. 59(2), pages 162-194, June.
  3. Matsen Egil & Sveen Tommy & Torvik Ragnar, 2007. "Savers, Spenders and Fiscal Policy in a Small Open Economy," The B.E. Journal of Macroeconomics, De Gruyter, vol. 7(1), pages 1-35, August.
  4. N. Gregory Mankiw, 2000. "The Savers-Spenders Theory of Fiscal Policy," NBER Working Papers 7571, National Bureau of Economic Research, Inc.
  5. Fernando Broner & Alberto Martín & Jaume Ventura, 2006. "Sovereign Risk and Secondary Markets," Working Papers 288, Barcelona Graduate School of Economics.
  6. Harold L. Cole & Timothy J. Kehoe, 1998. "Self-fulfilling debt crises," Staff Report 211, Federal Reserve Bank of Minneapolis.
  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. Emine Boz, 2009. "Sovereign Default, Private Sector Creditors and the IFIs," IMF Working Papers 09/46, International Monetary Fund.
  9. Douglas W. Diamond & Zhiguo He, 2012. "A Theory of Debt Maturity: The Long and Short of Debt Overhang," NBER Working Papers 18160, National Bureau of Economic Research, Inc.
  10. Bagnoli, M. & Bergstrom, T., 1989. "Log-Concave Probability And Its Applications," Papers 89-23, Michigan - Center for Research on Economic & Social Theory.
  11. Michael Tomz & Mark L. J. Wright, 2007. "Do Countries Default In "Bad Times"?," CAMA Working Papers 2007-23, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  12. 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.
  13. Tirole, Jean, 2012. "Country Solidarity, Private Sector Involvement and the Contagion of Sovereign Crises," IDEI Working Papers 761, Institut d'Économie Industrielle (IDEI), Toulouse, revised Sep 2012.
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